INCOME TAX CONSEQUENCES
SIGNED INTO LAW OCTOBER 3 2008
The historical financial markets rescue bill includes over 100 tax provisions and over $150 billion in separate tax breaks. In addition to the major tax provisions that directly address current financial bailout measures, the new law includes a much-anticipated alternative minimum tax (AMT) patch, an extensive package of tax extenders, energy incentives, disaster relief, and more. The Emergency Economic Stabilization Act’s $150 billion in tax incentives impacts both individuals and businesses. Approximately $44 billion in offsets, however, mean tax increases for certain groups.
Comment. A version that contained only rescue plan provisions failed in the House on September 29. The Senate then took the lead, gambling on linking the AMT patch, extenders, and disaster relief to the rescue plan, and won.
Impact. Although the new law’s primary purpose is to solve the credit crunch in the financial markets, it also serves as one of the largest tax bills in recent years. The new law makes almost 300 changes to the Internal Revenue Code. While roughly $150 billion in tax breaks had to be computed over a requisite 10-year period for budget scoring purposes, the lion’s share of that outlay provides taxpayer relief immediately in 2008 and 2009. Consequently, year-end tax planning takes on a special urgency this year to maximize taxpayer use of these new tax breaks both before 2008 ends and immediately at the start of 2009.
Alternative Minimum Tax Patch
For certain individuals who have to many deductions the tax code has provisions for an “alternative” minimum tax. In recent years far too many taxpayers have been qualifying for the AMT even though they are not the super wealthy.
Congress included an alternative minimum tax (AMT) patch in the new law. Under the new law’s patch for the 2008 tax year, the AMT exemption amounts are $69,950 for married couples filing jointly and surviving spouses, $46,200 for single taxpayers and heads of household, and $34,975 for married couples filing separately for 2008.
Impact. The patch is designed to insulate middle-income taxpayers from the reach of the AMT. The AMT patch will cost $61.8 billion when measured against what would have been collected without it.
Reminder. The patch is only for 2008. Hopes are high that in 2009 Congress finally will face up to the need to find a permanent solution to the AMT and pass AMT reform rather than yet another patch.
Nonrefundable Personal Credits The patch allows taxpayers to take nonrefundable personal credits to reduce their AMT liability. The law also removes limits in the AMT on taking personal credits against regular tax liability.
Comment. Personal credits include the dependent care credit and education tax credits. The adoption, child and saver’s credit were already allowed in full against the AMT and regular tax.
INDIVIDUAL INCOME TAX INCENTIVES
SIGNED INTO LAW OCTOBER 3 2008
The historical financial markets rescue bill includes over 100 tax provisions and over $150 billion in separate tax breaks. In addition to the major tax provisions that directly address current financial bailout measures, the new law includes a much-anticipated alternative minimum tax (AMT) patch, an extensive package of tax extenders, energy incentives, disaster relief, and more. The Emergency Economic Stabilization Act’s $150 billion in tax incentives impacts both individuals and businesses. Approximately $44 billion in offsets, however, mean tax increases for certain groups.
Comment. A version that contained only rescue plan provisions failed in the House on September 29. The Senate then took the lead, gambling on linking the AMT patch, extenders, and disaster relief to the rescue plan, and won.
Impact. Although the new law’s primary purpose is to solve the credit crunch in the financial markets, it also serves as one of the largest tax bills in recent years. The new law makes almost 300 changes to the Internal Revenue Code. While roughly $150 billion in tax breaks had to be computed over a requisite 10-year period for budget scoring purposes, the lion’s share of that outlay provides taxpayer relief immediately in 2008 and 2009. Consequently, year-end tax planning takes on a special urgency this year to maximize taxpayer use of these new tax breaks both before 2008 ends and immediately at the start of 2009.
Alternative Minimum Tax Patch
For certain individuals who have to many deductions the tax code has provisions for an “alternative” minimum tax. In recent years far too many taxpayers have been qualifying for the AMT even though they are not the super wealthy.
Congress included an alternative minimum tax (AMT) patch in the new law. Under the new law’s patch for the 2008 tax year, the AMT exemption amounts are $69,950 for married couples filing jointly and surviving spouses, $46,200 for single taxpayers and heads of household, and $34,975 for married couples filing separately for 2008.
Impact. The patch is designed to insulate middle-income taxpayers from the reach of the AMT. The AMT patch will cost $61.8 billion when measured against what would have been collected without it.
Reminder. The patch is only for 2008. Hopes are high that in 2009 Congress finally will face up to the need to find a permanent solution to the AMT and pass AMT reform rather than yet another patch.
Nonrefundable Personal Credits The patch allows taxpayers to take nonrefundable personal credits to reduce their AMT liability. The law also removes limits in the AMT on taking personal credits against regular tax liability.
Comment. Personal credits include the dependent care credit and education tax credits. The adoption, child and saver’s credit were already allowed in full against the AMT and regular tax.
INDIVIDUAL INCOME TAX INCENTIVES
Tax relief for individual taxpayers in the new law primarily comes in the form of a handful of popular “extenders.” These encompass tax breaks that, for many taxpayers, have been considered as permanent provisions because of the expectation of automatic renewal every year or two.
State and Local Sales Tax Deduction
The American Jobs Creation Act of 2004 and subsequent legislation allowed individuals to deduct state and local general sales taxes in lieu of state and local income taxes. This deduction expired at the end of 2007. The new law makes the deduction retroactive for 2008 and extends it for two years through December 31, 2009.
Reminder. Taxpayers can calculate their deduction by either saving receipts or using the Optional State Sales Tax Tables provided by the IRS.
Higher Education Tuition Deduction
The new law extends through December 31, 2009, the above-the-line (arriving at adjusted gross income bottom of page one of form 1040) higher education tuition deduction. The deduction allows eligible taxpayers to deduct the costs of qualified higher education expenses paid during the year for themselves, a spouse, or a dependent.
Comment. The deduction continues to be barred to taxpayers whose filing status is married filing separately, or if another person can claim an exemption for the taxpayer as a dependent on his or her tax return.
Impact. The maximum deductible amount is $4,000 for taxpayers with adjusted gross income not exceeding $65,000 ($130,000 for joint filers). Taxpayers whose income exceeds that limit but does not exceed $80,000 ($160,000 for joint filers) may deduct up to $2,000 in qualified expenses. For many taxpayers, the HOPE or Lifetime Learning credit is also an option.
Additional Standard Deduction for Real Property Taxes
The new law extends the additional standard deduction for real property taxes for non-itemizers through 2009. Congress authorized a maximum $500 additional standard deduction ($1,000 for joint filers) in the Housing Assistance Tax Act of 2008 but made it available only for the 2008 tax year.
Reminder. The deduction is in addition to the standard deduction. It is not an above-the-line deduction that lowers a taxpayer’s adjusted gross income (AGI). For 2008, the $10,900 standard deduction for joint filers will increase to a maximum of $11,900 with the additional standard deduction for non-itemizers, while the $5,450 standard deduction for single individuals will increase to a maximum $5,950, and the head-of-household amount from $8,000 to $8,500.
Teachers’ Classroom Expense Deduction
For 2008 and 2009, teachers and other education professionals can deduct, above the line, up to $250 of certain out-of-pocket classroom expenses, including the cost of books, supplies, equipment, and software used in the classroom. First introduced in 2002, this deduction is available to qualified educators regardless of whether or not they itemize their deductions.
Comment. Expenses that exceed $250 and non-classroom supplies may be deducted as an employment-related miscellaneous itemized deduction subject to the two-percent floor for taxpayers who itemize.
Tax-Free Distributions from IRAs for Charitable Purposes
The new law permits taxpayers to make tax-free distributions from IRAs for charitable purposes through December 31, 2009. This popular charitable contribution option had expired January 1, 2008. The maximum contribution limit for 2008 and again for 2009 is $100,000.
Impact. This treatment applies to traditional and Roth IRAs. However, no charitable deduction is allowed for any portion of these withdrawals that would have been otherwise taxable.
More Individual Incentives The new law also extends:
Treatment of certain dividends of Regulated Investment Companies (RICs)
Estate tax look-through for RIC stock held by nonresidents
Qualified investment entities treatment
CHILD TAX CREDIT
The new law enhances the child tax credit. The credit is currently refundable to the extent of 15 percent of the taxpayer’s earned income in excess of approximately $12,050 (reflecting inflation adjustments from the original floor of $10,000). Under the new law, the earned income floor falls to $8,500. Additionally, the rescue plan changes the definition of a “qualifying child” with respect to age and joint returns, clarifies the tiebreaker rules and ties the child tax credit to the child dependency exemption.
BUSINESS TAX INCENTIVES
The new law includes a host of incentives targeted to businesses, several of which revise as well as extend tax benefits. Among the most significant are revised research tax credit, enhanced depreciation for leasehold and restaurant improvements, and brown fields remediation.
Research Tax Credit
The new law extends the research tax credit to amounts paid or incurred in 2008 and 2009. It also modifies the credit, increasing the alternative simplified credit while repealing the alternative incremental research credit.
Comment. Congress first created the alternative simplified credit in 2006. The credit was 12 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding tax years. The new law raises the percentage to 14 percent and makes some technical corrections.
Leasehold and Restaurant Improvements
Under the new law, qualifying restaurant improvements and leasehold improvements will be eligible for 15-year cost recovery rather than a 39-year period for two more years, through December 31, 2009. Similarly, Congress authorized a 15-year recovery period for depreciation of certain improvements to retail space. This treatment is extended through December 31, 2009.
Impact. The treatment applies to retailers that own their buildings as well as retailers that lease.
Charitable Contributions
The Tax Code gives businesses enhanced deductions for contributions of food to charitable organizations, as well as contributions of books and computer equipment to qualifying schools. The new law extends these tax breaks through December 31, 2009. Additionally, Congress extended the temporary suspension of limitations on charitable contributions in the case of a qualified farmer or rancher contributing food before January 1, 2009.
Comment. S corp shareholders are also eligible for special tax treatment when making charitable contributions of qualifying property. The new law extends the special rule allowing S corp shareholders to take into account their pro-rata share of charitable deductions even if such deductions would exceed such shareholder’s adjusted basis in the S corp through December 31, 2009.
New Markets Tax Credit
The new law extends the New Markets Tax Credit through December 31, 2009.
Impact. The New Markets Tax Credit encourages taxpayers to invest in or make loans to small businesses in economically distressed areas. In today’s credit crunch, extension of the New Markets Tax Credit may prove especially valuable to those businesses.
Hurricane Katrina Relief
After Hurricane Katrina devastated the Gulf Coast, Congress passed a package of tax incentives to help individuals and businesses recover. One provision enhanced the Work Opportunity Tax Credit for Hurricane Katrina-affected employers. The new law extends this provision through 2009. Another Katrina-related incentive, the increased rehabilitation credit for structures in the Gulf Opportunity Zone, is also extended through 2009.
More Business Extenders The new law also extends:
Seven-year straight-line cost recovery for motorsports complexes; The special domestic production activities deduction in Puerto Rico; Qualified Zone Academy Bonds; District of Columbia first-time homebuyer tax credit; Indian employment credit; and over a dozen more targeted provisions.
OFFSETS
The new law includes more than $43 billion in revenue raisers, which only partially offset the cost of the extenders and other tax provisions. One of the most expansive offsets is broker basis reporting. Another offset plugs a foreign deferred compensation loophole and still another extends an employment surtax.
Broker Basis Reporting
Reporting by brokers has been expanded. Brokers must report the adjusted basis of publicly traded securities when reporting sales transactions and indicate whether gain is long-term or short-term. Securities subject to the new reporting requirement include stocks, bonds, debentures, commodities, derivatives, and other financial instruments designated by Treasury. Reporting will take effect for stock acquired in 2011, mutual funds acquired in 2012, and other securities acquired in 2013. The provision is estimated to raise $6.7 billion over 10 years.
Comment. Brokers will use the first-in, first-out (FIFO) method or the average cost method to determine basis, unless the taxpayer provides specific identification of the securities being sold.
Foreign Deferred Compensation
Nonqualified deferred compensation plans maintained by foreign corporations will generally become taxable, unless the compensation is deferred 12 months or less after the end of the year that the compensation vests. The tax can also apply to partnerships with foreign partners. Deferred compensation will be taxable when the amount is determinable. If the compensation is not determinable when it is deferred, the individual must pay a 20 percent surtax, plus interest, when the amount is determinable. The law applies to compensation for services performed after 2008 and is expected to raise $25 billion.
Comment. This provision is aimed at compensation schemes for executives who are paid by an entity that is located in a low- or no-tax jurisdiction and is “indifferent” to the arrangement because it is not losing a deduction when it defers the income. The provision does not apply to an entity whose income is taxable in the U.S. or subject to a “comprehensive foreign income tax.”
For the full CCH Tax Briefing
SUMMARY OF THE “EMERGENCY ECONOMIC STABILIZATION ACT OF 2008
SECTION-BY-SECTION ANALYSIS OF THE LEGISLATION
State and Local Sales Tax Deduction
The American Jobs Creation Act of 2004 and subsequent legislation allowed individuals to deduct state and local general sales taxes in lieu of state and local income taxes. This deduction expired at the end of 2007. The new law makes the deduction retroactive for 2008 and extends it for two years through December 31, 2009.
Reminder. Taxpayers can calculate their deduction by either saving receipts or using the Optional State Sales Tax Tables provided by the IRS.
Higher Education Tuition Deduction
The new law extends through December 31, 2009, the above-the-line (arriving at adjusted gross income bottom of page one of form 1040) higher education tuition deduction. The deduction allows eligible taxpayers to deduct the costs of qualified higher education expenses paid during the year for themselves, a spouse, or a dependent.
Comment. The deduction continues to be barred to taxpayers whose filing status is married filing separately, or if another person can claim an exemption for the taxpayer as a dependent on his or her tax return.
Impact. The maximum deductible amount is $4,000 for taxpayers with adjusted gross income not exceeding $65,000 ($130,000 for joint filers). Taxpayers whose income exceeds that limit but does not exceed $80,000 ($160,000 for joint filers) may deduct up to $2,000 in qualified expenses. For many taxpayers, the HOPE or Lifetime Learning credit is also an option.
Additional Standard Deduction for Real Property Taxes
The new law extends the additional standard deduction for real property taxes for non-itemizers through 2009. Congress authorized a maximum $500 additional standard deduction ($1,000 for joint filers) in the Housing Assistance Tax Act of 2008 but made it available only for the 2008 tax year.
Reminder. The deduction is in addition to the standard deduction. It is not an above-the-line deduction that lowers a taxpayer’s adjusted gross income (AGI). For 2008, the $10,900 standard deduction for joint filers will increase to a maximum of $11,900 with the additional standard deduction for non-itemizers, while the $5,450 standard deduction for single individuals will increase to a maximum $5,950, and the head-of-household amount from $8,000 to $8,500.
Teachers’ Classroom Expense Deduction
For 2008 and 2009, teachers and other education professionals can deduct, above the line, up to $250 of certain out-of-pocket classroom expenses, including the cost of books, supplies, equipment, and software used in the classroom. First introduced in 2002, this deduction is available to qualified educators regardless of whether or not they itemize their deductions.
Comment. Expenses that exceed $250 and non-classroom supplies may be deducted as an employment-related miscellaneous itemized deduction subject to the two-percent floor for taxpayers who itemize.
Tax-Free Distributions from IRAs for Charitable Purposes
The new law permits taxpayers to make tax-free distributions from IRAs for charitable purposes through December 31, 2009. This popular charitable contribution option had expired January 1, 2008. The maximum contribution limit for 2008 and again for 2009 is $100,000.
Impact. This treatment applies to traditional and Roth IRAs. However, no charitable deduction is allowed for any portion of these withdrawals that would have been otherwise taxable.
More Individual Incentives The new law also extends:
Treatment of certain dividends of Regulated Investment Companies (RICs)
Estate tax look-through for RIC stock held by nonresidents
Qualified investment entities treatment
CHILD TAX CREDIT
The new law enhances the child tax credit. The credit is currently refundable to the extent of 15 percent of the taxpayer’s earned income in excess of approximately $12,050 (reflecting inflation adjustments from the original floor of $10,000). Under the new law, the earned income floor falls to $8,500. Additionally, the rescue plan changes the definition of a “qualifying child” with respect to age and joint returns, clarifies the tiebreaker rules and ties the child tax credit to the child dependency exemption.
BUSINESS TAX INCENTIVES
The new law includes a host of incentives targeted to businesses, several of which revise as well as extend tax benefits. Among the most significant are revised research tax credit, enhanced depreciation for leasehold and restaurant improvements, and brown fields remediation.
Research Tax Credit
The new law extends the research tax credit to amounts paid or incurred in 2008 and 2009. It also modifies the credit, increasing the alternative simplified credit while repealing the alternative incremental research credit.
Comment. Congress first created the alternative simplified credit in 2006. The credit was 12 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding tax years. The new law raises the percentage to 14 percent and makes some technical corrections.
Leasehold and Restaurant Improvements
Under the new law, qualifying restaurant improvements and leasehold improvements will be eligible for 15-year cost recovery rather than a 39-year period for two more years, through December 31, 2009. Similarly, Congress authorized a 15-year recovery period for depreciation of certain improvements to retail space. This treatment is extended through December 31, 2009.
Impact. The treatment applies to retailers that own their buildings as well as retailers that lease.
Charitable Contributions
The Tax Code gives businesses enhanced deductions for contributions of food to charitable organizations, as well as contributions of books and computer equipment to qualifying schools. The new law extends these tax breaks through December 31, 2009. Additionally, Congress extended the temporary suspension of limitations on charitable contributions in the case of a qualified farmer or rancher contributing food before January 1, 2009.
Comment. S corp shareholders are also eligible for special tax treatment when making charitable contributions of qualifying property. The new law extends the special rule allowing S corp shareholders to take into account their pro-rata share of charitable deductions even if such deductions would exceed such shareholder’s adjusted basis in the S corp through December 31, 2009.
New Markets Tax Credit
The new law extends the New Markets Tax Credit through December 31, 2009.
Impact. The New Markets Tax Credit encourages taxpayers to invest in or make loans to small businesses in economically distressed areas. In today’s credit crunch, extension of the New Markets Tax Credit may prove especially valuable to those businesses.
Hurricane Katrina Relief
After Hurricane Katrina devastated the Gulf Coast, Congress passed a package of tax incentives to help individuals and businesses recover. One provision enhanced the Work Opportunity Tax Credit for Hurricane Katrina-affected employers. The new law extends this provision through 2009. Another Katrina-related incentive, the increased rehabilitation credit for structures in the Gulf Opportunity Zone, is also extended through 2009.
More Business Extenders The new law also extends:
Seven-year straight-line cost recovery for motorsports complexes; The special domestic production activities deduction in Puerto Rico; Qualified Zone Academy Bonds; District of Columbia first-time homebuyer tax credit; Indian employment credit; and over a dozen more targeted provisions.
OFFSETS
The new law includes more than $43 billion in revenue raisers, which only partially offset the cost of the extenders and other tax provisions. One of the most expansive offsets is broker basis reporting. Another offset plugs a foreign deferred compensation loophole and still another extends an employment surtax.
Broker Basis Reporting
Reporting by brokers has been expanded. Brokers must report the adjusted basis of publicly traded securities when reporting sales transactions and indicate whether gain is long-term or short-term. Securities subject to the new reporting requirement include stocks, bonds, debentures, commodities, derivatives, and other financial instruments designated by Treasury. Reporting will take effect for stock acquired in 2011, mutual funds acquired in 2012, and other securities acquired in 2013. The provision is estimated to raise $6.7 billion over 10 years.
Comment. Brokers will use the first-in, first-out (FIFO) method or the average cost method to determine basis, unless the taxpayer provides specific identification of the securities being sold.
Foreign Deferred Compensation
Nonqualified deferred compensation plans maintained by foreign corporations will generally become taxable, unless the compensation is deferred 12 months or less after the end of the year that the compensation vests. The tax can also apply to partnerships with foreign partners. Deferred compensation will be taxable when the amount is determinable. If the compensation is not determinable when it is deferred, the individual must pay a 20 percent surtax, plus interest, when the amount is determinable. The law applies to compensation for services performed after 2008 and is expected to raise $25 billion.
Comment. This provision is aimed at compensation schemes for executives who are paid by an entity that is located in a low- or no-tax jurisdiction and is “indifferent” to the arrangement because it is not losing a deduction when it defers the income. The provision does not apply to an entity whose income is taxable in the U.S. or subject to a “comprehensive foreign income tax.”
For the full CCH Tax Briefing
SUMMARY OF THE “EMERGENCY ECONOMIC STABILIZATION ACT OF 2008
SECTION-BY-SECTION ANALYSIS OF THE LEGISLATION
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