The Education, Jobs, and Medicaid Assistance Act of 2010

By Chad Koebnick, CPA, MBT

Editor: Neal A. Weber, CPA

Foreign Income & Taxpayers

P.L. 111-226, informally known as the Education, Jobs, and Medicaid Assistance Act of 2010, was signed into law by President Barack Obama on August 10, 2010, effective for tax years beginning after December 31, 2010. The act made significant changes to foreign tax credits under the Code. The changes include:

  • New Sec. 909, which creates a “matching rule” to prevent the splitting of foreign tax credits from associated foreign income;
  • Amendment of Sec. 901, adding subsection (m) to deny foreign tax credits in covered acquisition transactions where the foreign income is not subject to U.S. tax; and
  • Amendment of Sec. 960 to limit the amount of foreign taxes deemed paid as a means of preventing affirmative use of the “hopscotch” rule as a foreign tax credit planning device under Sec. 956.

Many business organizations have voiced opposition to the new law, pointing out that the new provisions impose de facto tax increases to the marginal tax rate of U.S. enterprises operating outside the United States.

U.S. Foreign Tax Credit System

In the United States, citizens, residents, and businesses are taxed on worldwide income, regardless of whether the income was generated from within the United States. To mitigate double taxation of income, the U.S. taxpayer can offset foreign taxes paid with a credit against its U.S. tax liability. Thus, the U.S. taxpayer may elect a credit for foreign taxes paid or accrued dollar for dollar against its U.S. tax liability. The U.S. tax system allows a credit for direct tax payments (i.e., foreign taxes paid directly by a U.S. company). In addition, the system also allows credit for taxes paid at the subsidiary level when income is repatriated to the United States. Specific ownership requirements must be met to be eligible for indirect credits.

If the taxpayer does not elect the foreign tax credit, it may deduct the foreign taxes paid against its taxable income. Taxpayer circumstances dictate whether the credit or the deduction produces a greater benefit. The purpose behind the foreign tax credit is to ensure that U.S.-based businesses are not harmed by the worldwide tax system. Checks and balances, as well as limitations, are built into the statutory regime to guard against abuse and maintain functional consistency across U.S. taxpayers.

There are several inherent limitations used to avoid abuse:

  • The foreign tax credit is limited to the amount of U.S. tax that would be imposed on the foreign-sourced income were the tax credit not available. This limitation is calculated by multiplying the taxpayer’s foreign-source income by the U.S. tax rate.
  • Sec. 904(c) limits the amount of credit utilized against the U.S. tax liability to the amount determined in the above computation. Taxpayers may carry back the excess to the previous year and carry forward the remaining excess to the subsequent 10 tax years.
  • Cross-crediting of taxes generated by different types of income is prohibited.

The credit limitation is limited not only by the Sec. 904(c) computation. In addition, streams of income are broken into separate classes. Credits from one income class are not allowed as a credit against another class of revenue. For example, income generated by operating a business cannot be credited against passive investment income. Therefore, a limitation is computed separately for each class of income, often eliminating the opportunity to credit low tax income with higher taxed credits. The foreign tax credit limitation is applied separately to income in the passive income basket and to the general income basket; credits for foreign tax in one basket cannot be used to offset U.S. tax on income in the other basket.

Foreign Tax Credit Modifications

Sec. 909 Foreign tax credit anti-splitter rules: New Sec. 909 generally provides that “if there is a foreign tax credit splitting event with respect to a foreign income tax paid or accrued by the taxpayer, such tax shall not be taken into account.” A splitting event occurs when foreign income to which foreign taxes relate is recognized for U.S. income tax purposes by a “covered person,” yet the affiliated income is not taken into United States income in the same period. A covered person is:

  • Any person in which the taxpayer holds, directly or indirectly, at least a 10% interest by vote or value in that person;
  • Any person where the taxpayer is an entity that is at least 10% (by vote or value) directly or indirectly owned by the person;
  • Any person where the taxpayer is related to the person under Sec. 267(b) or Sec. 707(b); or
  • Any other person specified by the IRS.

The new rule was put in place to address perceived abuse and exploitation of the technical taxpayer rule established with Biddle, 302 U.S. 573 (1938). That rule provides that the taxes are considered paid by whomever foreign law imposes legal liability for such tax, even if another person (e.g., a withholding agent) remits the tax. Prior to the law change, taxpayers combined the technical taxpayer rule with a deferral of foreign tax credits to separate creditable foreign taxes from related foreign-source income. The perception is that the loophole was created where the use of hybrid entities and hybrid debt instruments allowed the technical taxpayer to be a foreign entity, while the hybrid nature allowed the entity to be disregarded for U.S. tax purposes. Separation or splitting has allowed taxpayers to maximize credits claimed against foreign source income in a manner that mismatched the recognition of income and taxes.

The new Code section puts forth the concept of splitting events, but guidance necessary to apply the concept is lacking. The new law leaves significant ambiguity around the definition of a “splitting event” as well as the definition of “related income.” Taxpayers and practitioners will need to follow closely the expected guidance from the IRS and adapt their tax planning accordingly.

Sec. 901(m)—Covered acquisitions: Sec. 901(m) addresses perceived tax windfalls to taxpayers that structure acquisitive transactions to step up basis on assets for U.S. tax purposes, and thereby receive deductions on value not otherwise taxed through the U.S. system. Sec. 901(m) provides that “in the case of a ‘covered asset acquisition,’ the disqualified portion of any foreign income tax determined with respect to the income or gain attributable to the relevant foreign assets . . . shall not be taken into account in determining the [foreign tax] credit.” A covered asset acquisition refers to:

  • A qualified stock purchase (as defined in Sec. 338(d)(3)) to which Sec. 338(a) applies;
  • Any transaction that is treated as the acquisition of assets for U.S. tax purposes and as the acquisition of stock (or is disregarded) for purposes of the foreign income taxes of the relevant jurisdiction;
  • Any acquisition of an interest in a partnership that has an election in effect under Sec. 754; and
  • To the extent provided by the IRS, any other similar transactions that result in an increase to the basis of assets for U.S. tax purposes without a corresponding increase for foreign tax purposes.

Sec. 901(m)(2): The term “disqualified portion” means, with respect to any covered asset acquisition, for any tax year, the amount of foreign tax associated with a stepped-up basis generating U.S. deductions where the basis amount is not otherwise available for deduction for foreign tax purposes. The disqualified portion of the foreign tax is the ratio (expressed as a percentage) of (1) the aggregate basis differences (but not below zero) allocable to the tax year at issue for all relevant foreign assets, divided by (2) the income on which the foreign income tax is determined.

Sec. 901(m)(3): While the primary purpose of making the election to step up the basis is to eliminate the foreign tax attributes, Sec. 901(m)(3)(A)(ii) makes it clear that foreign law can no longer be ignored because the denominator of the disqualified portion computation is based upon foreign, not U.S., law (see Jackman and Tretiak, “Cross-Border Business Combinations,” 36 Int’l Tax J. (September–October 2010), for an example of the disqualified portion computation).

Congress’s intent was to “prevent taxpayers from claiming the foreign tax credit with respect to foreign income that is never subject to U.S. taxation because of a covered asset acquisition” (Ways and Means Committee, Summary of “The American Jobs and Closing Tax Loopholes Act of 2010” (H.R. 4213) at 21 (May 28, 2010)). Under the old rules, taxpayers structured transactions in a way that allowed the transaction to be considered a purchase of assets for U.S. tax purposes (i.e., a Sec. 338 or 754 election) because, under Sec. 1012, the taxpayer obtained a cost basis (usually a basis step-up) for U.S. tax purposes in the acquired assets. The increased asset basis allowed planning around increased depreciation and amortization deductions for U.S. tax purposes on the acquired assets. Sec. 901(m) eliminates the benefit of the basis step-up in the transaction by disqualifying a portion of foreign income tax associated with the basis step-up not available for deduction for foreign tax purposes. In addition, Congress also intended Sec. 901(m) to limit cross-crediting schemes.

This new Code section does not completely eliminate the foreign tax credit associated with covered asset acquisitions; instead it limits the amount of foreign tax credits allowed. However, the disqualified portion of foreign income tax may still be taken as a deduction.

In sum, Sec. 901(m) imposes formidable modifications to the foreign tax credit regime that may have negative consequences for U.S. companies. First, Sec. 901(m) is likely to impair the ability of U.S. companies seeking to expand through acquisition. The increased depreciation and amortization proffered by the basis step-up allowed for a reduction of U.S. tax on distributions back to the United States when the tax savings were factored into the equation. In losing this rate benefit, U.S. companies may find that they cannot afford to make the acquisition.

Second, the elimination of a portion of the foreign tax credit may also make U.S. companies less competitive in acquiring foreign targets, since the new rule seems to apply to both related and unrelated party transactions. Finally, there is insufficient guidance on how the computations should be done (i.e., transaction-by-transaction basis versus aggregate basis). Nevertheless, Sec. 901(m) disallows a foreign tax credit for the disqualified portion of any foreign income tax paid or accrued when the taxpayer engages in a covered asset acquisition. The new rule affects covered asset acquisitions that occur after December 31, 2010.

Sec. 960 Modification of the hopscotch rule: New Sec. 960(c) limits the amount of foreign tax credit that a U.S. taxpayer may associate with the inclusion of income from an investment in U.S. property under Sec. 956. Sec. 960(c) provides:

(c) Limitation with respect to section 956 inclusions—

(1) In general. If there is included under section 951(a)(1)(B) in the gross income of a domestic corporation any amount attributable to the earnings and profits of a foreign corporation which is a member of a qualified group (as defined in section 902(b)) with respect to the domestic corporation, the amount of any foreign income taxes deemed to have been paid during the taxable year by such domestic corporation under section 902 by reason of subsection (a) with respect to such inclusion in gross income shall not exceed the amount of the foreign income taxes which would have been deemed to have been paid during the taxable year by such domestic corporation if cash in an amount equal to the amount of such inclusion in gross income were distributed as a series of distributions (determined without regard to any foreign taxes which would be imposed on an actual distribution) through the chain of ownership which begins with such foreign corporation and ends with such domestic corporation.

This limitation has its genesis in the hopscotch rule that requires U.S. taxpayers to treat foreign income included under Sec. 956 from a multiple tier structure as if it were paid directly to the U.S. parent, while treating the foreign taxes as if they were paid through each tier of the structure before reaching the U.S. parent. Overall, Sec. 960(c) has modified the hopscotch rule’s affirmative use of Sec. 956 to repatriate cash to the United States without providing an offsetting benefit.

With this statutory change, it is now likely that companies may enter into a hopscotch rule as part of an integrated transaction to either utilize an expiring credit or otherwise generate foreign-source income. The key in any Sec. 956 transaction after the imposition of the new rules in Sec. 960(c) is to be extremely comfortable with tax attributes of the middle tier subsidiaries so that the tax planning results expected are achieved notwithstanding Sec. 960(c).


Congress intended the Education, Jobs, and Medicaid Assistance Act provisions to address several areas of perceived abuse by taxpayers and their advisers, particularly splitting transactions and perceived advantages of hybrid instruments and entities. However, the complexities of the new law and affiliated ambiguities related to critical operating definitions leave taxpayers and their advisers in a very difficult situation. The current state of the new laws and their lack of clarity are likely to inhibit taxpayers from arranging their affairs in a manner that best complies with the new rules. Rather, until significant additional guidance is provided, taxpayers and their advisers are left to speculate about actual application of the new rules. In many cases, taxpayers will be left without sufficient time or statutory integrity to make sound decisions about the day-to-day activities of their business.


Neal Weber is managing director-in-charge, Washington National Tax, with RSM McGladrey, Inc., in Washington, DC.

For additional information about these items, contact Mr. Weber at (202) 370-8213 or

Unless otherwise noted, contributors are members of or associated with RSM McGladrey, Inc.

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