26 U.S.C. § 7518 — Tax incentives relating to merchant marine capital construction funds

(a) Ceiling on deposits A vessel owner or lessee who signs an agreement under chapter 535 of title 46, United States Code, can set up a "capital construction fund" for their ships (called "agreement vessels"). Each year, the most that can be deposited into the fund is the sum of four amounts: the part of the owner's or lessee's taxable income for the year that comes from running the agreement vessels in foreign or domestic commerce, or in U.S. fisheries — figured without counting any net operating loss or net capital loss carried back, and without applying this section; the depreciation deduction allowed for the year under section 167 for the agreement vessels; if not already counted in the first amount, the net proceeds from selling an agreement vessel, or from insurance or indemnity for one; and any earnings the fund makes from investing or reinvesting its own money. If the owner leases the vessel instead of owning it, there's a limit: whatever amount the owner is required or permitted to deposit for that vessel under the depreciation-based amount above, the lessee's own deposit under that same amount gets reduced by that much. "Agreement vessel" also includes barges and containers that are part of the vessel's normal equipment and are named in the agreement. (b) Requirements as to investments Fund money must be kept in the depository named in the agreement, under trustee and fiduciary rules the Secretary sets. Normally, the fund can only be invested in interest-bearing securities the Secretary approves. With the Secretary's consent, up to 60% of the fund's assets can instead go into the stock of domestic corporations — but only stock that is fully listed and registered on a national securities exchange, and that a careful, well-informed investor seeking steady income and safety of capital would buy. If the stock in the fund ever grows to be worth more than the agreed percentage of the fund's assets, future investments and withdrawals must be managed in a way that brings the fund back toward that limit. Nonvoting preferred stock of a corporation is treated as meeting these requirements too, as long as that corporation's common stock would qualify, and the only reason the preferred stock can't be listed and registered is that it's nonvoting. (c) Nontaxability for deposits Making deposits into the fund reduces taxes in several ways: taxable income for the year goes down by whatever amount of vessel-operation income was deposited that year; gain from selling a vessel, or from insurance or indemnity proceeds, isn't counted as taxable gain if the net proceeds are deposited into the fund; earnings the fund makes from investing its money — including gains and losses — aren't counted as income while they stay in the fund; a corporation's "earnings and profits" are figured as if this section and chapter 535 of title 46 didn't exist; and when figuring the accumulated earnings tax under section 531, money sitting in the fund doesn't count. These tax breaks apply only to amounts deposited on time, under the agreement and the joint regulations. (d) Establishment of accounts The fund must be split into three accounts: the capital account, the capital gain account, and the ordinary income account. The capital account holds: depreciation-based deposits; sale, insurance, or indemnity proceeds, except the part that was taxable gain; the deductible share of any dividend the fund receives; and tax-exempt interest under section 103. The capital gain account holds gains on fund assets held more than 6 months, minus losses on assets held more than 6 months. The ordinary income account holds: vessel-operation income; gains on assets held 6 months or less, minus losses on assets held 6 months or less; taxable interest and other ordinary income the fund earns (not counting the tax-exempt interest or deductible dividend share already placed in the capital account); ordinary income from selling a vessel or from insurance or indemnity proceeds; and the taxable part of any dividend the fund receives. Capital losses can only offset gains of the same kind — long-held losses offset long-held gains, short-held losses offset short-held gains — except when the fund is finally closed out. (e) Purposes of qualified withdrawals A withdrawal is "qualified" only if it follows the agreement's terms and pays for: buying, building, or rebuilding a qualified vessel; buying, building, or rebuilding barges or containers that are part of a qualified vessel's equipment; or paying down debt used to buy, build, or rebuild a qualified vessel, barge, or container. Except as regulations allow, barges and containers under the second purpose — and the barge or container part of the third — must have been built in the United States. If the Secretary decides someone isn't meeting a major obligation under their agreement, the Secretary can, after notice and a chance for a hearing, treat all or part of the fund as if it had been withdrawn improperly — a "nonqualified withdrawal." (f) Tax treatment of qualified withdrawals Qualified withdrawals come out of the accounts in this order: first the capital account, second the capital gain account, third the ordinary income account. If part of a qualified withdrawal for a vessel, barge, or container comes from the ordinary income account, that vessel's, barge's, or container's basis (the value used to figure future gain or loss) is reduced by that amount. The same rule applies to amounts coming from the capital gain account. If part of a qualified withdrawal used to pay down debt comes from the ordinary income or capital gain account, that same kind of basis reduction is applied — in the order joint regulations set — across the vessels, barges, and containers the person owns. Any part of the withdrawal left over after that is instead treated as a nonqualified withdrawal. If property whose basis was reduced this way is later disposed of, any gain from that disposal — up to the total amount the basis was reduced — is treated as if it were an amount withdrawn from the ordinary income account on the date of the disposal. This doesn't apply if the person redeposits an amount, set under joint regulations, that restores the fund to roughly where it was before the withdrawal. (g) Tax treatment of nonqualified withdrawals Except as covered in subsection (h), any withdrawal that isn't a qualified withdrawal is a nonqualified withdrawal. Nonqualified withdrawals come out of the accounts in the opposite order: first the ordinary income account, second the capital gain account, third the capital account. Within each account, amounts are normally treated as withdrawn oldest-first — except two kinds, which are treated as withdrawn newest-first: withdrawals for research, development, and design costs for new and advanced ship design, machinery, and equipment; and amounts treated as nonqualified under the basis-reduction rule described above. Tax treatment: an amount from the ordinary income account is included in gross income as ordinary income for the year of the withdrawal. An amount from the capital gain account is included in income for that year as a gain from an asset held more than 6 months. For the period up to the tax due date for the year of the withdrawal: no interest under section 6601 and no addition to tax under section 6651 applies; instead, interest at a special "applicable rate" applies to the extra tax on these amounts, running from the tax due date for the year the money was originally deposited in the fund; and no interest applies to the 25-year-rule amounts described below, or to a nonqualified withdrawal arising from the recapture rule in section 606(5) of the Merchant Marine Act, 1936, as in effect on December 31, 1969. The "applicable rate" of interest for a nonqualified withdrawal is set jointly, for each year, by the Secretary of the Treasury and the applicable Secretary. It's pegged to 8%, adjusted to reflect how the prior year's money rates and investment returns compare to those for calendar year 1970. 25-year rule: an increasing share of any amount left in the fund a long time after it was deposited is automatically treated as a nonqualified withdrawal — 20% at the close of the 26th taxable year after the deposit year, 40% at the close of the 27th, 60% at the close of the 28th, 80% at the close of the 29th, and 100% at the close of the 30th. A fund's earnings for a year (other than net gains) are treated as deposited that year for this rule. An amount is not treated as "remaining" in the fund, though, if there is already a binding contract, by the close of that year, for a qualified withdrawal of that amount for a specific identified item. If the Secretary decides a fund's balance is more than is appropriate for that person's vessel construction plans, the excess is treated as a nonqualified withdrawal — unless the person develops real program objectives within 3 years to use up that excess. Amounts already in a fund on January 1, 1987, are treated as deposited on that date. Tax rate: for the year of a nonqualified withdrawal (including a 25-year-rule amount), the withdrawal is excluded from gross income, but the regular tax for that year is increased by the withdrawal amount multiplied by the highest tax rate under section 1 (section 11 for a corporation). For a taxpayer other than a corporation, the part of a nonqualified withdrawal from the capital gain account is taxed at no more than 20% where section 1(h) applies. If part of a nonqualified withdrawal is properly traced to deposits — not deposit earnings — that did not reduce the taxpayer's tax liability in an earlier year, that part is treated differently: it isn't taxed under the rule just described, and instead an equal amount is treated as if it were allowed as a deduction under section 172 for the year of the withdrawal. Any amount excluded from gross income this way is also excluded when figuring taxable income under section 172(b)(2). (h) Certain corporate reorganizations and changes in partnerships Under joint regulations, a transfer of a fund from one person to another, as part of a transaction to which section 381 applies, may be treated as if it were not a nonqualified withdrawal. A similar rule applies to a continuation of a partnership. (i) Definitions Any term this section uses that is also defined in chapter 535 of title 46, United States Code — including the term "Secretary" — has the meaning that chapter gave it as of the date this section became law.