Some say they’re a way to save on business taxes. The U.S. Congress has termed them “loopholes” and is looking at ways to close them.

Here’s what’s being considered under what’s known as the American Jobs and Closing Tax Loopholes Act:

Carried interest
“Carried interest” occurs when a partner receives an interest in future profits in exchange for services. That income is taxed at capital gains rates. The  House and Senate want to change the way carried interest will be taxed:

House

• Part of the income that is recharacterized would be taxed at ordinary income rates, which, for tax years beginning before 2013, would be 50%.
• For tax years beginning after January 1, 2013, that rate increases to 75%.
• No industries would be exempt. This provision would be effective now, for tax years ending in 2010.

Senate

• This bill would tax the recharacterized income at 65% beginning after 2012.
• The rate would be reduced to 55% for gain or loss from the sale of assets held at least seven years.
• For 2011 and 2012, the applicable tax rate would be 50%.
• A carve-out would exempt the recharacterized income from the sale of certain interests in energy-related public partnerships.

With the top ordinary income rate currently at 35% and the top capital gain rate currently at 15%, the tax hike would be enormous as it is. Plus, after 2011 the two ordinary income rates are expected to rise to 39.6% and 20%, respectively. In addition, ordinary income would be subject to self-employment taxes.

S corporations
Both House and Senate bills address what some lawmakers see as evasion of employment tax by certain individuals. The Internal Revenue Service has stated that many taxpayers receive nominal salaries and take their earnings through distributions by S corps., limited partnerships, or other entities. The House and Senate bills would change that situation by imposing self-employment payroll taxes on 100% of S-corp. pass-through income when:

• The S corp. is engaged in a professional service business, with the key assets being the reputation and skill of no more than three employees, or
• The S corp. is a partner in a professional service business.

Foreign Tax Credit Reforms
The foreign tax credit was intended to prevent double taxation on foreign-source income. But corporations have found ways to use the credit to reduce the taxes they pay in the United States.

The House and Senate have adopted a matching rule that prevents the separation of creditable foreign taxes from the related foreign income. The bill contains various provisions which suspend the recognition of foreign tax credits until the associated foreign income is taxed in the U.S. Further:

• Stock acquisitions that are treated as asset purchases generally qualify for a stepped-up basis. For foreign companies, the step-up cannot be used for foreign taxes, but only for U.S. taxes, in order to prevent taxpayers from claiming foreign tax credits against foreign income that was never taxed in the U.S.
• The foreign tax credit is limited to the top U.S. tax rate of 35%. The Obama administration states that some taxpayers are inflating foreign source income by using treaties to shift the source of some assets to their foreign branches. House and Senate reforms set aside this income so that it is not used to claim foreign tax credits.

The bill, HR 4213, as of this date is still going through various procedural measures.