Editor's note: This article appears in the January 2009 issue of The Tax Adviser, the AICPA's monthly journal of tax planning, trends and techniques.
On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008, P.L. 110-343. The act provides alternative minimum tax (AMT) relief, energy tax credits, and disaster relief for individuals. It also extends the availability of the exclusion from gross income of discharges of qualifying mortgage debt and several other provisions affecting individuals that had expired at the end of 2007 or were scheduled to expire at the end of this year. This item discusses the implications of those provisions.
The act provides individuals with several areas of relief from AMT liability.
Increased individual AMT exemption amounts: The 2008 exemption amounts are increased from:
- $45,000 to $69,950 for married couples filing jointly and surviving spouses;
- $33,750 to $46,200 for other unmarried individuals; and
- $22,500 to $34,975 for married individuals filing separate returns (Sec. 55(d)(1)).
Implications: The increase in the exemption amounts for 2008 is the latest in a series of annual increases. As in past years, this increase is effective for only one year. Under current law, the exemption is phased out at higher levels of alternative minimum taxable income (AMTI). The exemptions are fully phased out at $429,800 of AMTI for married couples filing jointly and surviving spouses ($297,300 for other unmarried individuals and $214,900 for married individuals filing separately) (Sec. 55(d)(3)(A)). This increases the income range in which AMT taxpayers would be subject to a marginal tax rate of as high as 22% on capital gains and qualified dividends (i.e., 15% + (.25 × 28%)).
AMT relief for personal tax credits: The act extends the ability of individuals to offset their entire regular tax and AMT liabilities with personal nonrefundable tax credits to tax years beginning in 2008 (Sec. 26(a)).
Implications: Eligible nonrefundable personal tax credits include the dependent care credit, the credit for the elderly and disabled, the adoption credit, the child credit, the credit for interest on certain home mortgages, the Hope scholarship and lifetime learning credits, the credit for savers, the credit for certain nonbusiness energy property, the credit for residential energy-efficient property, and the DC first-time homebuyer credit.
Increase in AMT refundable credit: The act extends and modifies the amount of the refundable AMT credit for longterm unused minimum tax credits (i.e., minimum tax credits attributable to tax years before the third tax year immediately preceding the current tax year). Under the act, 50% of long-term unused minimum tax credits may be refunded over each of two years, rather than 20% per year over five years as under previous law (Sec. 53(e)(2)). In addition, the adjusted gross income (AGI) phaseout for the refundable credit is eliminated.
The act also provides that any underpayment of outstanding tax on the enactment date of an AMT liability (and any penalty and interest related to such underpayment) attributable to the minimum tax adjustment for incentive stock options (ISOs) is abated (Sec. 56(b)(3)). Finally, the AMT refundable credit amount and the AMT credit for each of the first two tax years beginning after December 31, 2007, are increased by one-half the amount of any interest and penalty paid that would have been abated under the above rules had it not been paid before the enactment date (Sec. 53(f)(2)).
Implications: As a result of these changes, taxpayers can recover their entire balance of long-term unused minimum tax credits over two years regardless of their AGI. This provision may be particularly beneficial to taxpayers who have large minimum tax credit carryforwards due to the exercise of ISOs shortly before the tech stock crash of 2000–2001. Because the use of a minimum tax credit generated by an ISO adjustment often depends on the profitable sale of the stock received, many taxpayers in this position have been unable to use any significant portion of their available minimum tax credits in subsequent years.
The act extends the Sec. 25C credit for purchases of energy-efficient improvements to existing homes for two years through 2009. It also includes energyefficient biomass fuel stoves as a new class of energy-efficient property eligible for a consumer tax credit of $300.
The act also provides an eight-year extension of the credit for residential energyefficient solar property under Sec. 25D (through 2016). In addition, the act eliminates the current $2,000 cap on the credit for solar electric investments. The legislation also creates tax credits for residential small wind energy property ($4,000 cap) and geothermal heat pumps ($2,000 cap).
The act establishes a new credit for plug-in electric drive passenger cars and light trucks ranging from $2,500 to $7,500 (Sec. 30D).
The nonrefundable credits are allowed to offset both regular tax and AMT. The depreciable basis of the property acquired is reduced by the amount of the credit claimed.
Implications: The credits are intended to spur investment in these types of alternative energy property by making their use economically viable for a wider range of taxpayers.
THREE-YEAR EXTENSION OF DISCHARGED MORTGAGE DEBT INCOME EXCLUSION
The act extends (for three years through 2012) the temporary exclusion from gross income of discharges of qualified principal residence indebtedness (Sec. 108(a)(1)(E)). This exclusion was enacted in the Mortgage Forgiveness Debt Relief Act of 2007, P.L. 110-142.
Qualified principal residence indebtedness is defined as acquisition indebtedness (within the meaning Sec. 163(h)(3)(B), except that the dollar limitation is $2 million) with respect to the taxpayer’s principal residence. Acquisition indebtedness generally means indebtedness incurred in the acquisition, construction, or substantial improvement of the principal residence of the individual and secured by the residence. It also includes refinancing of such indebtedness to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.
The basis of the individual’s principal residence is reduced by the amount excluded from income.
Implications: This provision allows homeowners who are already in a tight financial position due to the decline in the real estate market to avoid a significant current year tax bill due to a mortgage write-off. Although the taxpayer is required to reduce his or her basis in the residence, due to the Sec. 121 exclusion of gain from the sale of a principal residence, the tax relief is likely to be permanent for many taxpayers.
OTHER EXTENDERS APPLICABLE TO INDIVIDUALS
The act extends the following to the end of 2009:
n The provision allowing a taxpayer to elect to take an itemized deduction for state and local general sales taxes instead of state and local income taxes (Sec. 164(b)(5)).
Implications: The provision continues to benefit residents of states with no state income tax. Because it is available to all taxpayers as an option, however, it may also benefit other taxpayers whose sales tax bill for the year exceeds their state income tax (for example, taxpayers who reside in a jurisdiction with a low income tax rate or who made large taxable expenditures during the tax year).
The sales tax deduction is a preference for AMT purposes and may be of little or no value to taxpayers exposed to the AMT. In such an instance, if a taxpayer itemizes for state tax purposes and can claim the sales tax deduction, the taxpayer may be better off deducting sales tax on the federal return despite the fact that the deduction results in no federal tax savings.
n The above-the-line tax deduction for qualified higher education expenses (Sec. 222). However, the act modifies the deduction so that it is unavailable for any tax year beginning in 2008 or 2009 if the taxpayer would, in the absence of the AMT, have a lower tax liability for that year if he or she elected the Hope or lifetime learning credit.
n A provision allowing teachers an above-the-line deduction for up to $250 in educational expenses (Sec. 62(a)(2)(D)).
n The additional standard deduction for real property taxes added by the Housing and Economic Recovery Act of 2008, P.L. 110-289, which would have expired at the end of 2008 (Secs. 63(c)(1)(C) and (c)(7)).
n The exclusion from gross income for distributions from a traditional or Roth IRA directly contributed to charity by individuals over age 70½ (Sec. 408(d)(8)). Distributions eligible for the exclusion may not exceed $100,000 per taxpayer per tax year. Furthermore, distributions in excess of $100,000 that otherwise meet the requirements for a qualified charitable distribution cannot be carried over to future years.
Implications: Qualifying IRA owners may recognize significantly greater tax benefits by using this provision to fund charitable donations than they would from making contributions from other accounts or property. Excluding IRA distributions that satisfy the requirements for qualified charitable distributions reduces AGI, which in turn reduces the various percentage limitations based on AGI that apply to itemized deductions and credits. Taxpayers may consider using Roth IRAs for qualified charitable distributions if the distribution would not otherwise be a qualified Roth IRA distribution.
n Adjustment of an S corporation shareholder’s stock basis by a pro-rata share of the adjusted basis of appreciated property donated by the corporation to charity (Sec. 1367(a)(2)).
Implications: Prior to the enactment of the Pension Protection Act of 2006, P.L. 109-280 (PPA), when an S corporation donated appreciated property that qualified for a fair market value deduction, the shareholder’s basis in his or her S corporation stock was reduced by the shareholder’s prorata share of the fair market value of the property. Consequently, when the S corporation shareholder ultimately sold shares, the shareholder would effectively pay tax on the appreciated value of the property that the S corporation had contributed to charity. This result differed from what the shareholder would have realized had he or she personally donated that appreciated property. In that case, the shareholder would not recognize the gain attributable to the appreciation. The act extends the change made by the PPA that aligns the tax results.
n The application of the estate tax lookthrough rule for stock held in a regulated investment company (RIC) to estates of nonresident decedents dying before January 1, 2010 (Sec. 2105(d)(3)). Under this rule, RIC stock owned by a nonresident decedent is not deemed to be property within the United States in the proportion that, at the end of the quarter of the RIC’s tax year immediately before the decedent’s date of death, the assets held by the RIC are debt obligations, deposits, or other property that would be treated as situated outside the United States if held directly by the estate.
The act liberalizes the casualty loss rules for individuals who are victims of a federally declared disaster that occurs after December 31, 2007, and before January 1, 2010. The act waives the rule under Sec. 165(h)(2) that a casualty loss is deductible only to the extent it exceeds 10% of the taxpayer’s AGI. However, the act also raises the $100 per casualty threshold under Sec. 165(h)(1) to $500. The act also allows nonitemizers to claim casualty losses as a standard deduction.
In addition to revising the casualty loss rules, the act extends the time period when taxpayers can carry back net operating losses attributable to a casualty loss incurred in a federally declared disaster from two to five years.
The act also provides tax relief for those affected by the floods, severe storms, and tornadoes in the Midwest (Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin) declared as disaster areas by FEMA on or after May 20, 2008, and before August 1, 2008 (Sec. 1400N).
CURRENT INCLUSION OF NQDC PAID BY TAX-INDIFFERENT
New Sec. 457A requires individuals who participate in a nonqualified deferred compensation (NQDC) plan of a tax-indifferent party (such as an offshore corporation in a low- or no-tax jurisdiction) to recognize such deferred compensation in gross income currently.
Implications: Such deferred compensation must be included in gross income regardless of whether the taxpayer ever actually or constructively receives the compensation. In essence, an individual is subject to income tax when the right to the compensation accrues, even if subsequent events eliminate the compensation or significantly reduce its value. While supposedly aimed at hedge fund managers operating in offshore tax havens, this provision actually affects a broader group of U.S. taxpayers who work in foreign countries for foreign companies, including employees of U.S. multinational corporations who earn deferred compensation from foreign entities.
—By Gary N. Cohen, J.D., MBA, Ernst & Young, LLP, Atlanta, and Todd A. Richardson, J.D., CPA, Ernst & Young, LLP, Indianapolis.