By Kenneth H. Bridges, CPA, PFS March 2009
On February 17, 2009, President Obama signed into law The American Recovery and Reinvestment Act of 2009. Highlights of the tax provisions in the legislation include:
Longer NOL carryback period – Under present law, net operating losses (NOLs) can only be carried back 2 years or forward 20 years. Under the new rules, NOLs incurred in 2008 by “small businesses” (those with average annual revenue of less than $15 million) can be carried back up to 5 years to recover tax paid in years 2003 – 2007.
Bonus first-year depreciation – For most new depreciable assets (other than buildings) placed in service during 2008, The Economic Stimulus Act (which was passed in early 2008) permitted 50% of the cost to be expensed immediately, with the balance recovered under the regular depreciation rules. This special first-year deduction applied both for regular tax and alternative minimum tax. For autos and light trucks, for which first-year depreciation would otherwise have been limited under the so-called “luxury automobile rules”, bonus depreciation of $8,000 could be taken (bringing the total deduction for such to approximately $11,000). These bonus depreciation rules were to have applied only for 2008. However, the new legislation extends the rules through 2009.
Extension of increased section 179 expense amount – The Economic Stimulus Act (enacted earlier this year) increased the amount of furniture and equipment purchases that businesses could elect to immediately expense to $250,000 for purchases made during 2008, and also increased the level of purchases at which this benefit would begin to be phased out to $800,000. The new legislation extends these amounts for another year.
Expansion of the Work Opportunity Tax Credit – The list of individuals qualifying employers for the Work Opportunity Tax Credit (WOTC) is expanded to include “unemployed veterans” (generally defined to include those who have been discharged from active duty within the past 5 years who have been receiving unemployment compensation for at least 4 weeks) and “disconnected youth” (generally defined as those between the ages of 16 and 25 who have not been in school or employed for the previous 6 months and who lack the basic skills to be employable). Employers hiring these individuals during 2009 or 2010 may be eligible for a tax credit of $2,400 per such person hired.
Extension of election by corporations to accelerate AMT & research credits instead of bonus depreciation – The ability of corporations otherwise eligible for bonus depreciation to instead elect to claim additional alternative minimum tax (AMT) credits or research tax credits is extended through 2009.
Deferral of income from cancellation of business indebtedness – Businesses which satisfy their debt at a discount, which would otherwise under current law have been cancellation of indebtedness income, can elect to defer the taxable income from such and recognize it over a 5 year period beginning in 2014.
Shortening of the “built-in gains tax” period for S-corps – C-corporations which make a Subchapter S election and then sell their assets within 10 years of electing S status are subject to a corporate level tax (the “built-in gains tax”) on any unrealized gains that existed at the effective date of the S election. For asset sales which occur during 2009 or 2010, the new legislation shortens this period to 7 years.
Increase in exclusion for gain on sale of Qualified Small Business Stock – Under current law, non-corporate taxpayers may exclude from taxable income 50% of the gain from the sale of “qualified small business stock” which has been held at least 5 years. While at first blush this exclusion sounds great, due to the fact that the remaining gain is subject to a 28% rate (and the fact that a portion of the excluded gain has to be added back for purposes of the alternative minimum tax), this provision has not been very beneficial. The new legislation increases the amount of the exclusion to 75%. The increased exclusion amount should mean an effective Federal regular tax rate on such gain of 7%, and an effective alternative minimum tax rate on such gain of 12.88% (rather than the 15% Federal rate which would otherwise apply to an individual’s long-term capital gain).
Reduced quarterly estimated tax payments for small business owners and employees – Under present law, in order to avoid a penalty for underpayment of estimated tax you must pay in quarterly at least 90% of your tax liability for the current year or 100% of your tax liability for the immediately preceding year (110% for those whose prior year income was more than $150,000). The new legislation provides that, for individuals whose prior year income was less than $500,000 and for whom at least 50% of their income came from a business with 500 employees or less, the prior-year-tax-liability safe harbor will be reduced to 90% of the prior year tax amount.
Subsidized COBRA coverage – Employees who are involuntarily separated from employment between September 1, 2008 and January 1, 2010 may elect to pay 35% of their COBRA coverage premiums and have the Federal government subsidize the balance via payroll tax credits to the employer for a 9-month period.
Loss limitations on banks reinstated – Tax rules discourage “trafficking” in net operating losses (NOLs) or other “built-in losses” by placing potentially severe limitations on the use of a company’s tax losses and tax credits following a change in ownership. Generally, if there is a more than 50-percentage point change in ownership during any 3-year period, the amount of the loss carryforwards or built-in losses which existed at the time of the ownership change which can be used in any future period is limited to the value of the company on the date of the ownership change multiplied by a fluctuating rate which is generally around 4%. In October 2008, the IRS shocked many of us in the tax professionals community by issuing a notice which effectively exempted banks from these rules. Many of us in the tax professionals community (and many in Congress as well) believed the IRS had likely overstepped its bounds. The new legislation repeals this IRS notice for changes in ownership occurring after January 16, 2009.
NOL limitations not to apply where EESA bail-out requires ownership restructuring – As noted above, the new legislation repeals the late 2008 IRS notice which effectively exempted banks from the limitations which apply to net operating losses and built-in losses after an ownership change. However, the same legislation exempts from the loss limitation rules any ownership change which occurs under a restructuring plan required under a loan agreement or a commitment for a line of credit entered into with the Treasury Department under the Emergency Economic Stabilization Act of 2008.
Increase in alternative minimum tax exemption – The alternative minimum tax (“AMT”) is a separate but parallel system to the regular income tax. You must compute your tax under both systems, and pay the greater of the two. If the AMT is higher than the regular tax then this excess shows up on your return as an additional tax. For 2008, married individuals filing jointly were permitted a maximum exemption in computing the AMT of $69,950 and singles were permitted a maximum exemption of $46,200. For 2009, these maximum exemption amounts (which are subject to phase-out for higher income taxpayers), were scheduled to be reduced to $45,000 and $33,750, respectively. This would have meant millions more taxpayers being subject to the AMT for 2009. To prevent this, Congress has increased the exemptions for 2009 to $70,950 and $46,700, respectively. This represents a tax savings of up to $6,747 for those directly affected.
Exclusion of private-activity bond interest from AMT – Under current law, interest on “private-activity bonds” (state and local bonds issued to provide financing for private purposes) is an add-back in computing alternative minimum tax (AMT). Under the new legislation, interest on private-activity bonds issued in 2009 or 2010 will not have to be added back in computing the AMT.
First-time homebuyer credit – Legislation enacted in 2008 provided for a first-time homebuyer tax credit of up to $7,500, which has to be repaid over a 15-year period. The new legislation increases the maximum credit to $8,000, and provides that it does not have to be repaid, provided that the taxpayer lives in the home for at least 3 years.
Making Work Pay credit – For 2009 and 2010, singles will be permitted a tax credit of up to $400 and married couples a tax credit of up to $800, computed based on 6.2% of earned income (not to exceed $6,452 in earnings for singles or $12,904 for married couples). The credit is phased out for singles with income over $75,000 or married couples with income over $150,000.
$250 Economic Recovery Payment – The new legislation provides for a onetime payment of $250 to individuals who are eligible for social security benefits, railroad retirement benefits, veterans compensation, supplement security income, or government retirement benefits.
New deduction for sales tax paid on purchase of new vehicle – A new deduction (which can be taken either as part of the standard deduction or as an additional itemized deduction) is provided for the sales tax paid on the purchase of a new vehicle. The deduction cannot exceed the portion of the tax attributable to the first $49,500 of the purchase price, and the deduction is phased out for singles with income over $125,000 or married couples with income over $250,000.
Hope education credit enhanced and renamed – The “Hope” education credit is renamed the “American Opportunity Tax Credit”, the maximum amount of such is increased from $1,800 to $2,500 per year, it may apply for the first 4 years of post-secondary education (versus 2 years under current law), it may be claimed against alternative minimum tax, and 40% of the credit is “refundable” (meaning that it can exceed your tax liability). The credit is phased out for singles with income over $80,000 and married couples with income over $160,000.
Section 529 plan distributions for computer expenses – For 2009 and 2010, tax-free distributions from section 529 plans may be used to pay for computers, computer technology, and internet access.
Unemployment compensation – Up to $2,400 of unemployment compensation benefits received in 2009 will be excluded from the recipient’s taxable income.
Increase in credit for nonbusiness energy efficiency improvements – The amount of the tax credit provided to individuals for qualified energy efficiency improvements and residential energy property expenditures incurred in 2009 and 2010 is increased to 30% of the amount expended, with the tax credit for such not to exceed $1,500.
The Worker, Homeownership, and Business Assistance Act of 2009
On November 6, 2009, President Obama signed into law The Worker, Homeownership, and Business Assistance Act of 2009. Highlights of the tax provisions in this legislation include:
Homebuyer credit – Legislation enacted in 2008 provided for a first-time homebuyer tax credit of up to $7,500, which had to be repaid over a 15-year period. Legislation enacted in early 2009, increased the maximum credit to $8,000 and provided that it did not have to be repaid, provided the taxpayer lives in the home for at least 3 years. The credit was available only for homes purchased prior to December 1, 2009, and the credit was phased out for single taxpayers with income between $75,000 and $95,000 and for married couples with income between $150,000 and $170,000. The new legislation extends the credit for principal residences purchased before May 1, 2010 (or July 1, 2010, if under contract as of May 1, 2010), increases the income levels for which the credit is available (the phaseout will be at income levels of $125,000 – $145,000 for singles and $225,000 – $245,000 for married couples), and makes the credit available not only for first-time homebuyers (generally defined as those who have not owned a home in the previous 3 years) but also “long-time residents” (generally defined as those who have had the same principal residence for any 5-consecutive year period during the preceding 8 years). For qualifying “long-time residents” the maximum credit is $6,500. The maximum credit is in all cases limited to 10% of the purchase price, and no credit is available for home purchases in excess of $800,000. In order to claim the credit, the taxpayer must be at least 18 years old and cannot be eligible to be claimed as a dependent on another taxpayer’s return. Also, the home cannot be purchased from a relative, and you must attach to your tax return a copy of the closing statement.
Extension and expansion of the 5-year NOL carryback period – Under present law, net operating losses (NOLs) can generally only be carried back 2 years or carried forward 20 years. Under legislation enacted in early 2009, the carryback period for losses incurred in 2008 was extended to 5 years, but only if the loss came from a business with average annual revenue of less than $15 million. The new legislation extends the 5-year NOL carryback period to cover losses incurred during 2009 (tax years beginning after 12/31/07 and before 1/1/10), and expands it to cover businesses of all sizes (i.e. not limited to those with average annual revenue of less than $15 million). The amount of the loss which can be carried back to the 5th preceding year cannot exceed 50% of income from that carryback year. Taxpayers which may have elected to forego the NOL carryback for an NOL arising in 2008 (e.g. because they were, under prior law, limited to a 2-year carryback) or who may have filed a carryback claim going back only two years will now have an opportunity to change the election they previously made. Also, the corporate rule which limited use of an alternative minimum tax NOL carryback to 90% of income is suspended for tax years ending after 2002. The extended and expanded NOL provision is expected to yield $33 billion in refunds.
Increased penalty for late filing of partnership, LLC and S-corp returns – Legislation enacted in 2007 increased the penalty for late filing of returns for partnerships, LLCs and S-corps to $85 per partner, member or shareholder per month. The new legislation increases the penalty to $195 per month per partner, member or shareholder for a maximum of 12 months (i.e. up to $2,340 per Schedule K-1 filed). Accordingly, a partnership with 100 partners, for example, which fails to timely file its return could be facing a penalty of up $234,000.
Expansion of electronic filing requirements – Under present law, certain income tax returns are required to be filed electronically (e.g. returns of partnerships with more than 100 partners and returns for businesses which file at least 250 Federal returns of any type, including W-2s and 1099s), but for most other returns filing electronically is optional. We always file electronically in situations where required, and do so in other situations where the client prefers such (e.g. to expedite a substantial refund or where there are logistical challenges for the client with filing physical return timely). From the government’s perspective, electronic filing obviously reduces the cost of handling returns, but from our perspective it actually adds steps and time to the process. With electronic filing, we must first provide a copy of the returns to the client for their review and approval, receive back from the client a signed authorization form okaying our filing the returns electronically, submit the returns to the taxing authorities electronically, in some cases mail to the taxing authorities forms and schedules that cannot be filed electronically, check back later with the taxing authorities for verification that the e-filed returns were received, and retain documentation of such. The new legislation directs the IRS to require most returns prepared by tax professionals and filed after December 31, 2010 to be filed electronically.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.