ADOPTION CREDIT AND EXCLUSION EXPANDED
The Patient Protection and Affordable Care Act (PL 111-148) temporarily increased the adoption expense credit and fringe benefit exclusion limit for adoption-assistance programs and made the credit refundable. The changes are effective for tax years beginning after Dec. 31, 2009.
The act increased the statutory maximum credit and exclusion amount from $10,000 to $13,170 and, starting in 2011, changed from 2001 to 2009 the base period for annual cost-of-living adjustments of the credit and exclusion amounts and their phaseout threshold. With inflation adjustment, the pre-act credit and exclusion amount for 2010 would have been $12,170.
Before amendment by the act, the adoption credit was a nonrefundable personal credit, with any unused credit available for carryforward for up to five succeeding tax years. The act made the credit fully refundable in the year it is claimed. For a fuller description of the pre-act credit, see “Tax Treatment of Adoption Expenses,” JofA, April 10, page 44. The act also redesignated the adoption credit’s section of the Internal Revenue Code from section 23 to new section 36C, to place it in the refundable credits subpart of the Code. The adoption- assistance program fringe benefit exclusion remains in section 137.
Before amendment by the act, the maximum credit had been scheduled to revert at the end of 2010 with the sunset of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, PL 107-16) to $6,000 for special-needs children only, with no inflation indexing and no credit for non-special-needs children. The phaseout threshold likewise would have decreased, to $75,000 and also with no inflation adjustment. In addition, the adoption program income exclusion would have expired with the sunset because it had been extended by the EGTRRA past its originally scheduled expiration at the end of 2001.
The Patient Protection and Affordable Care Act delayed the EGTRRA’s sunset with respect to the adoption credit and exclusion by one year, until the end of 2011. Therefore, unless Congress again extends the sunset or makes the amendments permanent, at the end of 2011 the adoption credit will revert to its pre-EGTRRA provisions (with no credit for non-special-needs children), and the income exclusion will disappear.
NINTH CIRCUIT REVERSES ITSELF IN XILINX
The Ninth Circuit Court of Appeals affirmed the Tax Court’s holding that allowed a semiconductor company to deduct costs of employee stock options (ESOs) without having to share them with its Irish subsidiary in a joint venture (Xilinx v. U.S., docket nos. 06-74246 and 06-74269, 3/22/2010). Thus the Ninth Circuit overruled its own holding last year that had reversed the Tax Court (5/27/2009, withdrawn). For Tax Matters coverage of the earlier appellate decision, see “Related Parties Must Share Employee Stock Options Costs,” Oct. 09, page 69).
Xilinx and the subsidiary, Xilinx Ireland, entered a cost-sharing agreement for developing new technology that did not specifically address ESOs. Xilinx’s business expense deductions for tax years 1997 through 1999 included a total of $177 million in costs of employee exercises of options. It also claimed related research and development credits totaling $84 million. The IRS issued a deficiency, claiming the costs should have been shared with Xilinx Ireland. Xilinx cited Treas. Reg. § 1.482-1(b)(1), which says that the arm’s-length standard for determining taxable income of controlled parties is to be applied “in every case” and that uncontrolled parties operating at arm’s length typically do not share ESO costs as part of a cost-sharing agreement. The IRS countered with Treas. Reg. § 1.482-7(d)(1), which provides that controlled parties in a cost-sharing agreement must share all costs related to developing intangible assets. The Ninth Circuit said the two provisions were irreconcilable. (Since the tax years at issue, the regulations have been amended to specifically include ESOs in shared costs.)
In its earlier ruling, the Ninth Circuit held that the general requirement of the former provision did not override the more specific provision of the latter. In its redetermination, the court rejected that tenet of construction as “all too pat.” Rather, it said, the “dominant purpose” of the regulations should be respected: to provide parity between taxpayers in controlled and uncontrolled transactions.
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