Vol. 82, No. 4, April 2009
he American Recovery and Reinvestment Act of 20091 (ARRA), signed into law on Feb. 17, 2009, is one of the most massive and far-reaching pieces of legislation in American history. According to some economists, the nearly $800 billion bill is also one of the most important in a generation. Through direct spending on infrastructure in the public and private sectors, and nearly $300 billion in tax relief, the ARRA is intended to lift the economy out of recession through what President Obama calls “the first step to get our economy on the road to recovery and pave the way to long-term growth.”2
In all, the new law makes more than 300 changes to the Internal Revenue Code (IRC), aimed at providing tax relief and other benefits to individuals (primarily at the lower-and-middle income levels), businesses, and state governments. Among the changes are significant new tax breaks and enhancements like the “making work pay” credit, an enhanced first-time homebuyer credit program, a 2009 alternative minimum tax (AMT) credit, and energy incentives. Businesses will welcome extensions of 2008 bonus depreciation, increased IRC § 179 expensing, a five-year net operating loss (NOL) carryback for small businesses, and state and local government relief.
President Obama pushed hard for this legislation, believing that its tax and spending initiatives will encourage consumers to begin spending again and motivate businesses to upgrade and purchase new equipment, create jobs, invest in “green collar” jobs, and return a measure of prosperity to an otherwise bleak economy. Recent headlines indicate that the ARRA was just the first in a series of bills designed to stimulate or rescue the economy. Although history will judge the ARRA’s ultimate effects on the nation’s economy, tax advisors cannot sit back and wait for the results. Advisors need to take affirmative action to understand the ARRA’s various provisions and then take the appropriate action steps with their clients. The following summary of the ARRA’s fundamental tax law changes will provide advisors with a working knowledge of the Act that they can relay to their clients.
Tax Relief for Individuals and Families
Making Work Pay Credit. One of the signature provisions for individual taxpayers is the making work pay credit.3 It allows a credit against income tax in an amount equal to the lesser of 6.2 percent of an individual’s earned income or $400 ($800 for married couples filing jointly). It will apply retroactively to Jan. 1, 2009, and extend through 2010.
Individuals with modified adjusted gross income less than $75,000 ($150,000 for married couples filing jointly) will be eligible for the full credit. There is a 2 percent phase-out rate above that income level. Self-employment earnings are included to the extent that they are taken into account when computing taxable income.
Qualified taxpayers can take this credit either through a reduction in their wage withholding or in a lump sum when filing returns for the tax year. The impact of the credit is to effectively offset an individual taxpayer’s share of FICA payroll taxes for the first $6,452 in earnings ($12,904 for married couples filing jointly). The employer’s share of FICA (6.2 percent) will not change.
Nonresident aliens and individuals who can be claimed as a dependent by another taxpayer are not eligible to take this credit.
Economic Recovery Payment.4 One-time payments of $250 will be made to individuals on fixed incomes (primarily Social Security recipients, railroad retirees, and disabled veterans), although the timing and method of distribution has not yet been established. Retired government workers, who generally are not eligible for Social Security, will also receive the one-time payments of $250. These payments will reduce any making work pay credit to which the taxpayer would otherwise be entitled.
2009 AMT Patch.5 As expected, the ARRA includes an AMT patch that is designed to protect nearly 26 million middle-income taxpayers from the dreaded tax. Exemption amounts are now slightly above the 2008 patch levels: $70,950 for joint filers and surviving spouses (up from $69,950 in 2008), and $46,700 for single persons and heads of household (up from $46,200).
Enhanced First-time Homebuyer Credit.6 In 2008, Congress authorized a refundable tax credit of up to 10 percent of the cost of a home ($7,500 maximum) for first-time homebuyers who purchased a home between April 9, 2008, and July 1, 2009. Under the original provisions, the credit essentially was an interest-free loan that had to be repaid to the government over 15 years in equal installments (or earlier, if the home was sold). The credit phases out for taxpayers with adjusted gross income over $75,000 ($150,000 for married couples filing jointly).
The ARRA eliminates the repayment obligation (except when the home is sold within three years of purchase) for taxpayers purchasing homes after Jan. 1, 2009. It also increases the maximum value of the credit to $8,000 and removes the prohibition on financing by mortgage revenue bonds. Availability is extended to homes purchased by Dec. 1, 2009.
New Vehicle Sales Tax Deduction.7 The ARRA may provide a much-needed shot in the arm for the auto industry with a new deduction for state and local sales and excise taxes paid on the purchase in 2009 of new cars, light trucks, recreational vehicles, and motorcycles. The deduction cannot exceed the portion of the tax attributable to the first $49,500 of the purchase price and is phased out for taxpayers with adjusted gross income over $125,000 ($250,000 for married couples filing jointly). The deduction is effective for vehicles purchased on or after Feb. 17, 2009 (the date that the President signed the legislation).
Post-secondary Education Credits.8 A new name, a new maximum credit, and a broader scope are among the temporary changes in credits for education expenses. For 2009 and 2010, the newly named American opportunity tax credit (previously the HOPE education credit) will provide taxpayers with a new credit of up to $2,500 (per eligible student per year) of the cost of tuition and related expenses paid during the taxable year (up from a maximum of $1,800 under the HOPE education credit). Qualified taxpayers will receive a tax credit based on 100 percent of the first $2,000 of tuition and related expenses (including books) paid during the taxable year and 25 percent of the next $2,000 of tuition and related expenses. Forty percent of the credit will be refundable. The credit will phase out for persons with adjusted gross income over $80,000 ($160,000 for married couples filing jointly).
Jamey G. Rappis, Marquette 1993, is a senior tax manager in the Milwaukee office of Clifton Gunderson’s firmwide tax group and leads the firm’s IRS rulings and procedures services niche. He can be reached at email@example.com.
Like many other provisions, this credit is retroactive to Jan. 1, 2009. However, tuition paid late in 2008 for semesters beginning in 2009 only qualifies for the $1,800 limit for 2008.
Computers as Qualified Education Expenses for 529 Education Plans.9 IRC § 529 education plans are tax-advantaged savings plans that cover qualified education expenses, including tuition, room and board, mandatory fees, and books. In the past, computers have not been included as qualified, but for 2009 and 2010, the ARRA provides that computers, computer technology, and Internet access can be included as qualified education expenses.
Estimated Tax Payments.10 The new law decreases estimated tax payments for 2009 for individuals whose primary income comes from a small business. Instead of requiring such individuals to make quarterly estimated tax payments based on 100 percent of the tax liability shown on their 2008 returns, the new law allows computation based on 90 percent of the tax liability shown on 2008 returns.
To qualify, an individual’s adjusted gross income must be less than $500,000 and he or she must certify that more than 50 percent of the gross income shown on his or her return for the prior tax year was income from a small business. Income from a small business generally means income from a trade or business with an average number of employees of 500 or fewer.
Tax Incentives for Businesses
Extension of Bonus Depreciation.11 The Economic Stimulus Act12 gave businesses the opportunity to recover the costs of capital expenditures made in 2008 at an accelerated rate. Businesses could immediately write off 50 percent of the cost of depreciable property (such as equipment and computers) acquired in 2008 and used in the United States. The ARRA extends this temporary benefit to capital expenditures incurred in 2009.
Effective Jan. 1, 2009, the regular dollar cap for new vehicles placed in service in 2009 and used more than 50 percent for trade or business purposes also has been raised by $8,000 to $10,960 ($11,160 for light trucks and vans) if bonus depreciation is elected.
Extension of IRC § 179 Expensing Limits.13 Small-business taxpayers may elect to write off certain capital expenses in the year of acquisition instead of recovering these costs over time through depreciation. Under the old rules, small-business taxpayers are allowed to write off up to $125,000 (indexed for inflation) of capital expenditures, subject to a phase-out when capital expenditures exceed $500,000 (indexed for inflation). Last year, Congress temporarily increased the amount of write-offs for capital expenditures incurred in 2008 to $250,000 and increased the phase-out threshold for 2008 to $800,000. The new law extends these temporary increases for capital expenditures incurred in 2009.
Five-year Carryback of NOLs.14 Under prior law, any qualified business could carry back NOLs to the two taxable years before the year that the loss arose. Losses also could be carried forward to each of the succeeding 20 taxable years. The law has now changed, allowing small businesses (qualified businesses with average gross receipts of $15 million or less) with tax years ending in 2008, or beginning in 2008 with a special taxpayer election, to carry back NOLs for a period of three, four, or five years.
S Corporation Built-in Gain Period Shortened.15 The new law temporarily shortens, from 10 to seven years, the holding period for assets subject to the built-in gains tax imposed after a C corporation elects to become an S corporation under the tax code. The built-in gains tax prevents a C corporation from avoiding corporate level tax on the disposition of appreciated assets it acquired while a C corporation by first converting to S corporation status. The reduction in the holding period applies to S corporations that would otherwise recognize built-in gains during tax years beginning in 2009 and 2010.
Accelerated Recognition of Historic AMT/R&D Credits.16 Businesses will have another year to take advantage of a provision passed last year that allows businesses to accelerate the recognition of a portion of their historic AMT or research and development (R&D) credits in lieu of bonus depreciation. The amount that may be accelerated is based on the amount that the business invests in property that would otherwise qualify for bonus depreciation. This amount is capped at the lesser of 6 percent of historic AMT and R&D credits or $30 million. The new law extends this temporary benefit through 2009.
Work Opportunity Tax Credit.17 Before the ARRA, businesses were allowed to claim a work opportunity tax credit of 40 percent of the first $6,000 of wages paid to employees in one of nine targeted groups. The new law adds certain unemployed veterans and disconnected youths to the list of prospective employees hired in 2009 and 2010. To qualify, a veteran would need to be discharged or released from active duty during the five years before hiring and to have received unemployment compensation for more than four weeks during the year before being hired. To qualify as a disconnected youth, an individual must be between ages 16 and 25 and have not been regularly employed or attended school in the previous six months.
Cancellation of Debt Income.18 Under current law, cancellation of certain debt is generally included as income when the taxpayer cancels or repurchases the debt for an amount less than its adjusted issue price. The amount of cancellation of debt income is the excess of the old debt’s adjusted issue price over the repurchase price. Certain businesses now will be allowed to recognize cancellation of debt income over five years for specified types of business debt repurchased after Dec. 31, 2008, and before Jan. 1, 2011. Once made, the election is irrevocable.
Small-Business Capital Gains.19 Old tax law provided a 50 percent exclusion for the gain from the sale of certain small-business stock held for more than five years. The new law increases the exclusion to 75 percent for stock acquired after the date of enactment and before Jan. 1, 2011. To claim the exclusion, the business cannot have assets over $50 million and must conduct an active business or trade.
New-Markets Tax Credit.20 The ARRA extends and modifies this credit, which encourages economic investment in certain designated economic recovery zones. The ARRA increases the equity limitation to a total of $5 billion for 2008 and 2009. In addition, the law creates a new category of tax credit bonds for investment in designated economic recovery zones or otherwise qualified community development entities. This credit encourages business development in designated low-income communities or in business entities that use substantially all their capital to invest in low-income communities.
Implications for State Taxes
States may “decouple” from stimulus incentive provisions. The economic slowdown has severely affected virtually every state’s budget through substantially lower tax collections and higher unemployment. As seen with prior federal stimulus measures, states may not be able to allow tax deductions such as the 50 percent first-year bonus depreciation deduction and the IRC § 179 expense deduction at the state income tax level, and state legislators may choose to decouple, or not allow, the enhanced deductions. Since the Economic Stimulus Act of 2008 passed last February, approximately 33 states have so far chosen not to follow the federal lead in allowing the 50 percent first-year deduction at the state level. Approximately 21 states also have indicated they will not allow the increased § 179 deductions.
Similarly, many states likely will decouple from the accelerated depreciation and § 179 deductions in the ARRA. Taxpayers and advisors need to conduct proper research and consider specific state adoptions of any federal legislation to make sure state tax returns are filed correctly.
Strategic tax planning starts immediately. A great deal is riding on the American Recovery and Reinvestment Act of 2009, but only time will tell if this landmark legislation will provide the right amount of economic stimulus to turn around the struggling economy. Instead of waiting for the outcome, individuals, businesses, and their advisors should be planning strategies to maximize the benefits in the coming year and beyond.