American Recovery and Reinvestment Act of 2009 — Multiple Provisions for Business and Individual Taxpayers
Scott E. Vincent
Vincent, Fontg & Hansen, L.L.C.
Kansas City
The American Recovery and Reinvestment Act of 2009, signed into law on February 17, 2009 (Public Law 111-5, the “Recovery Act”), has multiple provisions and tax law changes affecting both business and individual taxpayers. Several key provisions are outlined below for reference with respect to your clients and practice, but this is not an complete outline of the Recovery Act. Please also note that many of these provisions are temporary in nature and, unless extended by future legislation, apply only through 2009 or 2010. As always, please be sure to reference the Recovery Act itself as well as developing IRS interpretations of the act and continuing tax law changes for any pending or planned transactions.
Business Taxpayer Provisions
Liberal expensing limits continued. The Recovery Act extends for one year the enhanced expensing rules for qualifying business machinery and equipment. For tax years beginning in 2009, the maximum amount that a business may expense is $250,000, and the expensing election begins to phase out when a business buys more than $800,000 of eligible assets. These dollar limits are the same as those that were in effect for 2008.
Bonus first year depreciation extended. Bonus depreciation was scheduled to be unavailable for most assets placed in service after 2008. The Recovery Act extends for one more year an extra “bonus” depreciation deduction for the first year new business assets are placed in service. The bonus first-year depreciation deduction generally equals 50 percent of the cost of qualified property (most types of tangible property other than buildings and their structural components, improvements to certain types of leased property, and most software) acquired and placed in service during 2009. Certain types of property with a long life, and certain types of aircraft, may be placed in service before January 1, 2011, and still qualify for the 50 percent bonus first-year depreciation allowance. Also, note that the otherwise allowable first-year depreciation deduction for business autos first placed in service in 2009 is increased by $8,000 under the Recovery Act.
Extended election to speed up recognition of accumulated AMT and R&D credits instead of claiming bonus depreciation. A law enacted last year provided an alternative tax break to bonus depreciation, allowing corporations otherwise eligible for bonus depreciation on qualifying assets placed in service in 2008 (or 2009 for certain longer lived assets) to instead elect to accelerate recognition of part of their accumulated pre-2006 research tax credits or certain alternative minimum tax credits. The Recovery Act extends this election so that it is available for property placed in service in 2009 (or 2010 for certain longer lived assets). This alternative choice requires a detailed analysis of a corporation’s tax situation to compare the relative benefits.
Deferred tax on debt forgiveness income when debt is repurchased. A business that repurchases its own debt for less than the outstanding amount of the debt is typically subject to discharge of indebtedness income. For debt repurchased in 2009 or 2010, the Recovery Act permits the tax owed on such debt discharge income to be paid over five years, beginning with 2014.
Small businesses may elect longer NOL carryback period. In general, net operating losses (NOLs) may be carried back two years and forward 20 years (different rules apply for certain specialized types of losses). For NOLs arising in a tax year beginning or ending in 2008, the Recovery Act permits small businesses to elect to increase the NOL carryback period from two years to three, four, or five years. A small business for this purpose is a trade or business (including one conducted in or through a corporation, partnership, or sole proprietorship) whose average annual gross receipts are $15 million or less for the three-tax-year period (or shorter period of existence) ending with the tax year before the year in which the loss arose. The longer NOL carryback period gives small businesses that experienced losses the ability to get immediate refunds of income taxes paid in earlier years.
S corporation built-in gain holding period shortened. An S corporation is generally a pass-though entity with income or loss items reported to its shareholders, who pay tax on their pro-rata shares of the S corporation’s income. However, if a business that was formed as a C corporation elects to become an S corporation (or an S corporation receives C corporation assets in a nontaxable transfer), the S corporation is taxed at the highest corporate rate (currently 35 percent) on all gains that were “built-in” at the time of the election if the gains are recognized during the first ten S corporation years. Under the Recovery Act, for tax years beginning in 2009 and 2010, this special holding period is shortened to seven years.
Bigger exclusion for sale of qualified small business stock. Before the Recovery Act, individuals could exclude 50 percent of their gain on the sale of qualified small business stock (QSBS) held for at least five years (60 percent for certain empowerment zone businesses). To qualify, QSBS must meet a number of conditions (e.g., it must be stock of a corporation that has gross assets that don’t exceed $50 million and that meets active business requirements). Under the Recovery Act, the percentage exclusion for gain on QSBS sold by an individual increases to 75 percent for stock acquired after February 17, 2009 and before January 1, 2011.
Reduced estimated taxes in 2009 for individuals with small businesses. To the extent that tax is not collected through withholding, individuals generally must make quarterly estimated tax payments of the “required annual payment.” The required annual payment is the lesser of: (1) 90 percent of the tax shown on the return or (2) 100 percent of the tax shown on the preceding year’s return (110 percent if adjusted gross income (AGI) for the preceding year exceeded $150,000). The Recovery Act provides that for a tax year beginning in 2009, the required annual payment for individuals with small businesses is the lesser of (1) 90 percent of the tax shown on the return for the tax year, or (2) 90 percent of the tax shown for the preceding tax year. An individual qualifies for this relaxed estimated tax payment rule only if adjusted gross income on their preceding year tax return is less than $500,000 ($250,000 if married filing separately) and at least 50 percent of the gross income shown on the previous year tax return was from a small trade or business (one that employed no more than 500 people, on average, during the calendar year ending in or with the preceding tax year).
More workers eligible for work opportunity tax credit (WOTC). Employers that hire workers from one or more targeted groups (e.g., long-term family assistance recipients) can claim a tax credit that varies with the type of person hired. For individuals beginning work for the employer after December 31, 2008, the Recovery Act creates a new targeted group for the WOTC, consisting of unemployed veterans and disconnected youth who begin work for the employer in 2009 or 2010.
Limited subsidy for COBRA continuation coverage. The Recovery Act provides a 65 percent subsidy for COBRA continuation premiums for up to nine months for workers who have been involuntarily terminated, and for their families. This applies to group health plans that are subject to the federal COBRA continuation coverage requirements or to similar requirements under state law. If a company has such a plan, and receives a 35 percent payment from someone eligible for the subsidy, it must make the remaining 65 percent premium payment. However, the company can be “paid back” by either offsetting its payroll tax deposits or claiming the subsidy as an overpayment at the end of the payroll quarter.
To qualify for premium assistance, a worker must be involuntarily terminated between September 1, 2008 and December 31, 2009. Workers who were involuntarily terminated between September 1, 2008 and February 17, 2009, but failed to initially elect COBRA because it was unaffordable, must be given an additional 60 days to elect COBRA and receive the subsidy. Terminated workers must be notified of their right to a COBRA continuation coverage subsidy. The subsidy is not taxable when received, but higher income recipients —t hose with modified adjusted gross income above $125,000 ($250,000 for joint filers) — will have to repay part or all of the subsidy with their tax returns.
Expanded fringe benefit. For months beginning on or after March 1, 2009 and before January 1, 2011, the Recovery Act increases the monthly exclusion for employer-provided transit and vanpool fringe benefits from $120 to $230. This figure is adjusted for inflation each year and could go up in 2010.
Individual Taxpayer Provisions
New Making Work Pay Credit. Individuals who work generally get a credit of up to $400 ($800 for joint filers). The credit is refundable, meaning it is payable even to individuals who owe no income tax. This change applies for 2009 and 2010. The credit is the lesser of 6.2 percent of earned income or $400 ($800 on a joint return). The credit is phased out for joint filers with modified adjusted gross income between $150,000 and $190,000 and other taxpayers with modified AGI between $75,000 and $95,000.
This credit does not involve separate checks from the IRS, as did last year’s stimulus payment. Rather, employers will automatically adjust withholding so that employees get slightly increased net paychecks. Employees with multiple jobs will need to adjust withholding so that multiple adjustments are not made. Self-employed taxpayers can effectively receive the credit in advance by reducing estimated tax payments.
One-time $250 payment or credit for others. The Recovery Act provides a one-time payment of $250 in 2009 to retirees, disabled individuals and SSI recipients receiving benefits from the Social Security Administration, Railroad Retirement beneficiaries, and disabled veterans receiving benefits from the U.S. Department of Veterans Affairs. It also provides a one-time refundable tax credit of $250 in 2009 to certain government retirees who are not eligible for Social Security benefits. The Making Work Pay credit is reduced by any $250 payment or credit received.
New sales tax deduction for vehicle purchases. For 2009, there is a new deduction for state and local sales and excise taxes paid on the purchase of new cars, light trucks, motor homes and motorcycles after February 16, 2009 and before January 1, 2010. The deduction generally is available regardless of whether the taxpayer itemizes deductions on Schedule A or claims the standard deduction.
The deduction is limited to the tax on up to $49,500 of the purchase price of an eligible motor vehicle. The deduction is phased out for joint filers with modified adjusted gross income between $250,000 and $260,000 and other taxpayers with modified AGI between $125,000 and $135,000.
For taxpayers who itemize deductions and choose the option to deduct state sales taxes in lieu of state income taxes, this new deduction is not available. This prevents these taxpayers from getting a double deduction for the sales taxes on the vehicle, but it also involves some tricky planning considerations because different rules apply to the optional deduction and the new deduction. For example, the new deduction is allowed against the alternative minimum tax but the optional deduction is not. Additionally, the optional deduction is subject to a limitation that caps the deduction for sales tax on a motor vehicle to the general sales tax rate.
Improved first-time homebuyer credit. Last year’s Housing Act included a refundable tax credit for first-time homebuyers equal to the lesser of 10 percent of the purchase price or $7,500 for qualifying purchases after April 1, 2008 and before July 1, 2009. The credit is essentially an interest-free loan because it has to be paid back to the government over 15 years. The Recovery Act has improved this credit for 2009 purchases by (1) eliminating the requirement to pay it back (subject to exceptions), (2) increasing the maximum credit to $8,000, and (3) making it available for purchases through November 2009.
Taxpayers can treat a 2009 purchase as having been made on December 31, 2008 and thus get an immediate refund when they file their 2008 taxes by the April 15, 2009 filing deadline. Taxpayers who have already filed their 2008 tax returns can file an amended 2008 return to get the credit for a 2009 purchase.
A first-time homebuyer is an individual (or spouse, if married) who had no present ownership interest in a principal residence in the U.S. during the three-year period before the purchase of the home to which the credit applies. The first time homebuyer credit, whether claimed in 2008 or 2009, phases out for individual taxpayers with modified adjusted gross income between $75,000 and $95,000 ($150,000–$170,000 for joint filers).
AMT relief. Alternative minimum tax (AMT) is generally calculated by starting with regular taxable income, applying various adjustments and preferences (such as addbacks for property and income tax deductions and dependency exemptions), and then subtracting an exemption amount (which phases out at higher levels of income). The result is multiplied by the AMT tax rate of 26 percent or 28 percent to arrive at tentative minimum tax. AMT applies only if the tentative minimum tax exceeds regular tax. Although it was originally enacted to target wealthy individuals with tax favorable activities, the AMT now applies to many middle-income taxpayers. Exemption amounts were scheduled to drop and fewer tax credits were to be available to offset AMT for 2009. The Recovery Act provides AMT relief for 2009 by (1) increasing the exemption amounts above last year’s levels and (2) allowing nonrefundable credits to offset AMT as well as regular tax.
American Opportunity credit for college expenses. For 2009 and 2010, the Recovery Act gives taxpayers a new “American Opportunity” tax credit of up to $2,500 of the cost of tuition and related expenses paid during the tax year. The tax credit is based on 100 percent of the first $2,000 of tuition and related expenses (including books) paid during the tax year and 25 percent of the next $2,000 of tuition and related expenses paid during the tax year. The credit is available for the first four years of post-secondary education in a degree or certificate program. Forty percent of the credit is refundable. The credit is phased out for taxpayers with modified AGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers).
Section 529 Plans expanded for technology expenses. Section 529 Education Plans are tax-advantaged savings plans that can also be used to pay qualified education expenses, including: tuition, room and board, mandatory fees and books. Under the Recovery Act, for 2009 and 2010, qualified education expenses under these plans include computer technology and equipment, as well as Internet access and related services.
Tax break for the unemployed. Unemployment compensation benefits ordinarily are fully taxable. However, under the Recovery Act, an individual does not have to pay tax on up to $2,400 in unemployment benefits received in 2009.
Refundable child credit expanded. A taxpayer receives a $1,000 tax credit for each qualifying child under the age of 17. Before the Recovery Act, this credit was refundable only to a limited extent. The Recovery Act makes the child credit refundable to a much greater extent for 2009 and 2010.
Bigger earned income tax credit (EITC). The Recovery Act makes various changes to the earned income tax credit for 2009 and 2010. These changes will result in a bigger EITC for some taxpayers. For example, in 2009, taxpayers with three or more qualifying children may claim a credit of 45 percent of earnings up to $12,570, resulting in a maximum credit of $5,656.50.
Increased transit and vanpool transportation fringe benefits. For months beginning on or after March 1, 2009 and before January 1, 2011, the Recovery Act increases the monthly exclusion for employer-provided transit and vanpool benefits from $120 to $230. This figure is adjusted for inflation each year and could go up in 2010.
Improved energy tax breaks. The Recovery Act includes a number of provisions that are designed to promote the creation and use of alternative forms of energy, including these new or improved energy tax breaks for individuals:
The Recovery Act extends the tax credit for energy-efficient improvements to existing homes through 2010 and modifies it in various ways so that a larger credit is possible after 2008.
Under pre-Recovery Act law, individuals could claim a 30 percent tax credit for qualified solar water heating property (capped at $2,000), qualified small wind energy property (capped at $500 per kilowatt of capacity, up to $4,000), and qualified geothermal heat pumps (capped at $2,000). For tax years beginning after 2008, the Recovery Act removes these individual dollar caps, making these expenditures eligible for an uncapped 30 percent credit.
The Recovery Act modifies and increases the existing new qualified plug-in electric drive vehicle credit.
For vehicles bought after February 17, 2009 and before January 1, 2012, the Recovery Act creates a new 10 percent nonrefundable personal credit for electric drive low-speed vehicles, motorcycles, and three-wheeled vehicles.
For property placed in service after February 17, 2009 and before January 1, 2012, the Recovery Act creates a new 10 percent credit, up to $4,000, for the cost of converting any motor vehicle into a qualified plug-in electric drive motor vehicle.
Needless to say, we can expect further changes as the new administration continues efforts to stimulate the economy. Please also be mindful that many of the changes outlined here are new and will require further development and implementation by the IRS, and several of the provisions are also temporary in nature. So, we and our clients should all be careful to check for continuing changes and updates as particular transactions arise.
Post-Script Note and Correction: A special thank you to reader Elizabeth Jones, Esq., who identified a correction to a year-end planning note from my November-December 2008 article – the IRS position on pre-paid mortgage interest is that even if paid before year-end the deduction is not allowed until the applicable interest period in most cases (see IRS Publication 936 and see IRC Section 461(g) for limited exceptions).