Background
The Capital Construction Fund (CCF) program helps owners and operators of U.S. flag vessels accumulate capital to modernize and expand the U.S. merchant marine fleet by allowing use of tax-deferred funds for future purchases such as vessel acquisition, construction, or reconstruction. The CCF program was created by the Merchant Marine Act of 1936 and is administered by the U.S. Department of Transportation Maritime Administration (MARAD) and the National Oceanic and Atmospheric Administration (NOAA)/National Marine Fisheries Service (NMFS).
On December 23, 2022, a significant CCF statute was amended, allowing more U.S. flag vessel owners and operators to potentially benefit from this unique tax deferral program.
Previously, the statute was worded to restrict the use of these tax-deferred CCF funds to “qualified vessels” operating in “United States foreign, Great Lakes, non-contiguous domestic, or short sea Transportation trade.” The James M. Inhofe National Defense Authorization Act for Fiscal Year 2023 eliminated these “qualified vessel” geographic trading restrictions, allowing many more U.S. flag vessel owner/operators to access this tax savings program.
Two Distinct CCF Agreement Vessel Categories
Before entering into a CCF agreement, the vessel owner or operator must first identify which vessels to include in the agreement as Schedule A “eligible vessels” and Schedule B “qualified vessels.” All vessels included must be constructed or reconstructed in the U.S. and operated in foreign or domestic U.S. commerce that primarily engages in carrying people, materials, goods, or wares over water.
- Schedule A “Eligible Vessels” produce the funds deposited into the CCF.
- Schedule B “Qualified Vessels” use qualified CCF withdrawals to construct, reconstruct, or acquire U.S. flag vessels.
Although Schedule A and B vessels have a great deal of freedom in how they may operate in domestic or foreign commerce, certain restrictions exist such as citizenship, financial capability, minimum deposits, and acceptable programs.
MARAD’s CCF Application Guidelines
For fishing vessels, a taxpayer must enter into a CCF agreement with the Secretary of Commerce through the NOAA or NMFS. For other vessels, CCF agreements are administered by MARAD. A taxpayer may apply at any time, but to be applicable to any given tax year, the CCF agreement must be executed and entered on or before the due date (with extensions) for filing the taxpayer’s federal tax return for that tax year.
The CCF agreement establishes certain parameters, and the owner must complete the following steps:
- Identify which vessels will be eligible for deferral of taxable income (Schedule A).
- Determine what kind of vessel or vessels are to be constructed, reconstructed, or acquired with the money in the CCF account (Schedule B).
- Establish where the tax-deferred income will be kept to pay for the Schedule B vessels; the taxpayer keeps the money in the CCF depository and the account is referred to as a CCF account.
The vessel owner decides which income will be segregated into the CCF account for the tax year and must deposit the money into the account on or before the due date for filing the taxpayer’s federal tax return for that tax year, with extensions. A taxpayer may make the CCF election after tax year-end for vessels already under construction, but only in the first year of eligibility. Going forward, the taxpayer will have funds available to help pay for Schedule B vessels.
The CCF account must be registered in the taxpayer’s name and remain separate from any other account. The Merchant Marine Act of 1936 specifies the types of investments the taxpayer can make with the funds. Annuities and repurchase agreements are prohibited. Approved investments include:
- Interest-bearing securities, e.g., federal, state, and local government bonds and domestic corporate bonds
- Common and preferred stocks of domestic companies
- Options, mutual funds, and money market funds, subject to additional complex rules
Deposits into the CCF reduce taxable income, and any income the fund produces is tax deferred unless the owner withdraws the income in the year earned, in which case it becomes taxable income.
Deposit Ceilings – Amounts Allowed to Be Deposited into the CCF Account
A taxpayer may deposit during any tax year the sum of the following ceilings for each vessel designated in the CCF agreement:
- Taxable income from agreement vessel operation
- Depreciation amount taken as a deduction on the vessel
- Net proceeds from the sale or other disposition of an agreement vessel (with the total amount of proceeds received required to be deposited)
- The earnings from investment or reinvestment of amounts deposited in the CCF
If a taxpayer’s deposits exceed the allowed annual ceiling into the CCF, the excess may be withdrawn as if never deposited or credited toward the next tax year’s ceiling if all past ceilings were filled.
Three Required Accounts
Each CCF must maintain three accounts covering capital, capital gains, and ordinary income:
- Capital Account – Contains deposits attributable to the depositor’s depreciation deduction for agreement vessels and the return of capital from the sale of agreement vessels, among other items; deposits into this account do not generate the CCF deduction, although the income generated by these deposits do receive tax deferral.
- Capital Gain Account – Contains capital gains from the sale or other disposition of an agreement vessel, including long-term capital gains from the investment amounts held in the fund.
- Ordinary Income Account – Contains deposits attributable to agreement vessel operations, short-term capital gains, and ordinary income from sale or disposition of agreement vessels, taxable interest, and other ordinary income.
Qualified withdrawals from the CCF are treated as being made first from the capital account, second from the capital gain account, and third from the ordinary income account. Qualified withdrawals from the capital gain and ordinary income accounts reduce the basis of the agreement vessel for which the withdrawal is made. Withdrawals in excess of the agreement vessel’s basis (Schedule B) reduce the basis of other vessels.
Nonqualified withdrawals from the CCF will be taxed in the year of withdrawal, including simple interest calculated on a first-in, first-out basis from tax year of original deposit to tax year of nonqualified withdrawal. Nonqualified withdrawals are treated as being made first from the ordinary income account, second from the capital gain account, and third from the capital account. With respect to the ordinary income account, the tax rate will be the highest marginal rate applicable for individuals and corporations and the applicable capital gains tax rates in effect will apply to both individuals and corporations. Nonqualified withdrawal amounts cannot be used to offset net operating losses. Any amount not withdrawn from the CCF within 25 years of deposit will be taxed as a nonqualified withdrawal.
Schedule B Tax Basis Consideration – The tax basis of the Schedule B asset purchased is reduced by the amount placed in the CCF, allowing the government to recapture the unpaid taxes when the CCF funds were deposited. The newly constructed, reconstructed, or acquired Schedule B asset, therefore, will have a lower depreciation deduction throughout its life to compensate for the tax the taxpayer deferred under the CCF agreement.
Conclusion
The CCF program essentially allows U.S. flag vessel owners and operators to segregate funds tax free for the future purchase of capital assets. The deferral of the tax due is comparable to an interest-free government loan. It’s designed to promote the modernization and expansion of the U.S. merchant marine fleet. And with the expansion of the amended definition of “qualified vessels” under the James M. Inhofe National Defense Authorization Act for Fiscal Year 2023, many more U.S. flag vessel owner/operators now have access to this tax savings program.
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