The Capital Construction Fund (“CCF”) program is a joint program of the Internal Revenue Service and the United States Maritime Administration which provides federal income tax incentives, mostly through tax deferral, to vessel owners and operators. The program is authorized both by Internal Revenue Code Section 7518 and by 46 USC 53501. The primary goals of the program are to ensure that there is a United States flagged fleet in case vessels are needed in time of war and to ensure we have domestic vessel production capacity for such purpose. Secondarily, the program creates jobs for vessel operators and domestic shipyards and assists in modernizing the United States merchant marine fleet. Program participants may defer income tax by depositing income from the operation of vessels, sales proceeds from the sale of vessels into a CCF account, much like a qualified retirement plan. Deposits into a capital construction fund may reduce a taxpayer’s taxable income or be excluded from income – depending upon the source of the deposits. Withdrawals used to pay for a vessel normally reduce a taxpayer’s federal income tax cost basis in the vessel for which the withdrawal is made but are otherwise tax-free. Earnings on CCF deposits are excluded from income. There are two separately administered CCF programs – one for commercial fishermen and one for commercial vessel operators. The rules for and administrators of the two programs differ.
Few states, if any, have state law-specific CCF tax rules. In Foret v. Louisiana Department of Revenue, Docket Number 13233C, the Louisiana Board of Tax Appeals (BTA) issued one of the few state judgements related to the state taxation of Capital Construction Funds. The Foret case involved the Louisiana state income tax treatment of contributions to a CCF of sales proceeds from the sale of a vessel. Louisiana taxes individuals, partnerships, and corporations in the same manner as the United States of America, subject to certain adjustments. For individuals, the starting point for computing Louisiana individual income tax is a taxpayer’s federal adjusted gross income (“AGI”). Louisiana has no specific statutes which address the state taxation of CCFs.
The facts in Foret are as follows:
- Prior to 2019, BJF, Inc. (“BJF”), an S Corporation, constructed a vessel for a total cost of $636,132.00. BJF made qualified withdrawals from its CCF of $313,790.00 to partially fund the construction of a vessel. In 2019, BJF sold its vessel for $575,000.00. For federal income tax purposes, the cost basis of the vessel was the original cost ($636,132.00) reduced by the CCF qualified withdrawals ($313,790.00), or $322,342.00. BJF reported a gain of $252,658.00 for federal income tax purposes which flowed through to the taxpayers on their personal federal income tax returns.
- For Louisiana income tax purposes, because BJF’s owners did not take a deduction for qualifying contributions made to its CCF in 2016 and 2017 for Louisiana income tax purposes, they reported a cost basis in the vessel for Louisiana income tax purposes of $636,132.00, which resulted in a loss of $61,132.00 to BJF on the sale of the vessel, which loss flowed through to Petitioners as BJF shareholders.
The State of Louisiana took the position that, for state income tax purposes, contributions to a CCF by an S Corporation were not deductible for Louisiana income tax purposes.
The State of Louisiana also took the position that for state income tax purposes withdrawals from a CCF account which reduce basis for federal income tax purposes also reduce basis for state income tax purposes even though the previous CCF contributions to the CCF were not state tax deductible. Thus, the State argued that when the vessel was sold, its proceeds would be taxed twice. First, state income tax was paid when the state did not permit state deductions for the contributions to the CCF. Second, state income tax should be due on the sales proceeds in the same manner as for federal purposes with the basis reduced from the CCF contributions. The taxpayers argued that to the extent Louisiana law does not recognize the CCF program, there must be corresponding adjustments to basis and/or depreciation under Louisiana law so that no double taxation of the vessel sales proceeds results for Louisiana income tax purposes. The Board of Tax Appeals ruled in favor of the taxpayers.
The Board of Tax Appeals reached the correct conclusion. Had the taxpayers in Foret just redeposited their vessel sales proceeds back into their CCF, the sale would have been tax-free for both Louisiana and federal tax purposes. Unlike profits contributed to a CCF from vessel operations which reduce taxable income (not AGI), profits from the sale of a vessel and from earnings earned from funds deposited in a CCF account are excluded from gross income entirely. IRC Section 7518(c)(1)(B) and (C); 46 CFR Appendix Sections 391.3(b)(1) and (b)(2) (“Such gain is to be excluded from gross income of the party” – not “adjusted gross income”). Federal AGI is only reduced by CCF contributions from vessel operating income. IRC Section 7518(c)(1)(A); 46 CFR Section 291.3((b)(1).
Many states have no laws about CCFs because such states are simply unaware of the existence of the federal program. More awareness of the benefits of the program should lead states to mimic the federal CCF program to foster their local maritime industries. With the 2022 expansion of the CCF program to include all vessels engaged in domestic trade, inland states, not just coastal states, can benefit from the CCF program.
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