On February 17, 2009, as part of a comprehensive economic stimulus plan, President Barack H. Obama signed into law the $787-billion American Recovery and Reinvestment Act of 2009 (ARRA). The administration and lawmakers hope the ARRA will aid in the country’s recovery from the current recession. Approximately one-third of the $787 billion is allocated to tax cuts that affect both businesses and individuals. This alert provides a general summary of some of the more important tax provisions of the ARRA for individuals.
Provisions Related to Alternative Minimum Tax (AMT)
Increased AMT Exemption Amounts for 2009. The AMT was originally enacted to make sure that individuals with high incomes and substantial tax deductions or credits did not escape income tax liability. However, an increasing number of middle-income taxpayers are finding themselves subject to AMT liability, due partly to the fact that the AMT exemption amounts (i.e., allowances that reduce taxpayers’ AMT income, thereby reducing or eliminating AMT liability) are not indexed for inflation. (The exemption amounts phase out for higher-income taxpayers.)
In recent years, Congress has spared millions of taxpayers from AMT liability by temporarily increasing the AMT exemption amounts. Prior to enactment of the ARRA, the AMT exemption amounts for 2009 were scheduled to decrease to the exemption amounts in place prior to the temporary increases. The ARRA provides another temporary one-year fix by increasing the AMT exemption amounts for 2009 as follows:
As noted previously, this is only a one-year “patch.” The AMT exemption amounts for 2010 and future years are still scheduled to be reduced as provided under pre-ARRA law. Thus, absent further legislative action, the exemption amounts for 2010 will decrease to $45,000 for married couples filing jointly, $33,750 for unmarried individuals, and $22,500 for married individuals filing separately.
Exemption of Interest on Private Activity Bonds Issued in 2009 or 2010 From the AMT. Interest on private activity bonds (i.e., state and local bonds issued to provide financing for private projects) is generally exempt from federal income tax, but the exemption does not apply for purposes of the AMT. Tax-exempt interest on such bonds (reduced by any deduction that would have been applicable if the interest were taxable) is a tax preference item that increases an individual’s taxable income in calculating AMT income. The ARRA provides that interest on private activity bonds issued in 2009 or 2010 will not be taken into account for AMT purposes. In other words, tax-exempt interest on such bonds is not a tax preference item for AMT purposes. Interest on refunding bonds is not a tax preference item for AMT purposes if the original private activity bond was issued after December 31, 2003 and before January 1, 2009, and refunded during 2009 or 2010.
Personal Nonrefundable Credits Can Offset AMT and Regular Tax for 2009. Under law prior to enactment of the ARRA, nonrefundable personal tax credits (other than the adoption expense credit, child tax credit, low-income saver’s credit, residential energy efficient property credit, and the nondepreciable property portion of the plug-in electric car credit) could not be used to offset AMT liability for tax years beginning after 2008. The ARRA provides a one-year patch by allowing nonrefundable personal credits to be used to reduce AMT and regular tax liability for 2009. (Such nonrefundable personal credits include, in addition to the credits previously listed, the child and dependent care credit, credit for the elderly and disabled, credit for interest paid or accrued on certain home mortgages of low-income individuals, credit for higher education expenses, residential energy efficient property credit, and the District of Columbia first-time homebuyer credit.)
Credits and Benefits That Phase Out Based on Income
“Making Work Pay” Credit. The ARRA provides eligible individuals with a refundable income tax credit (Making Work Pay Credit) for 2009 and 2010 equal to the lesser of (1) 6.2 percent of an individual’s earned income or (2) $400 ($800 for married individuals filing jointly). The credit is not available to nonresident aliens or to any individual who may be claimed as a dependent on another taxpayer’s return, and must be reduced by the amount of any economic recovery payment received by the taxpayer (see discussion of the $250 economic recovery payment below). It is anticipated that the credit will be implemented through revised income tax withholding schedules issued by the Internal Revenue Service (IRS) that will allow eligible individuals to receive this benefit through a reduction in the amount of income tax withheld from their paychecks. Alternatively, eligible individuals may claim the credit on their income tax returns.
The credit begins to phase out for taxpayers with modified adjusted gross income exceeding $75,000 ($150,000 for taxpayers filing jointly) and fully phases out for taxpayers with modified adjusted gross income exceeding $95,000 ($190,000 for taxpayers filing jointly).
American Opportunity Education Tax Credit. Pre-ARRA law provides for the Hope credit, a nonrefundable tax credit that individual taxpayers may claim for qualified tuition and related expenses paid for the first two years of an eligible student’s post-secondary education in a degree or certificate program. Qualified tuition and related expenses generally include tuition and fees, excluding nonacademic fees, required for an eligible student’s enrollment or attendance at a post-secondary educational institution. The credit rate is 100 percent of the first $1,200 of qualified tuition and related expenses, and 50 percent of the next $1,200 of qualified tuition and related expenses, up to a maximum of $1,800 per eligible student for 2009. The credit phases out for taxpayers with modified adjusted gross income exceeding $50,000 ($100,000 for taxpayers filing jointly).
The ARRA modifies the Hope credit (referring to it as the “American Opportunity Tax Credit”) for 2009 and 2010 by allowing a maximum $2,500 credit per eligible student per year for qualified tuition and related expenses paid for each of the first four years of the student’s post-secondary education in a degree or certificate program. Under the ARRA, the credit rate is 100 percent of the first $2,000 of qualified tuition and related expenses, and 25 percent of the next $2,000 of qualified tuition and related expenses. In addition, the ARRA expands the definition of qualified tuition and related expenses to include course materials and allows the credit to be claimed against AMT liability. The credit phases out for taxpayers with modified adjusted gross income exceeding $80,000 ($160,000 for taxpayers filing jointly).
Credit for First-Time Homebuyers. In 2008, Congress enacted a tax credit available to first-time homebuyers. A taxpayer qualifies as a first-time homebuyer if the taxpayer had no ownership interest in a principal residence in the United States during the three-year period before the purchase of the residence to which the credit applies. The credit is equal to 10 percent of the cost of a principal residence (up to $7,500 for married individuals filing jointly and single individuals, and $3,750 for married individuals filing separately) purchased on or after April 9, 2008 and before July 1, 2009, and is subject to a repayment provision pursuant to which the credit amount is recaptured ratably over 15 years, with no interest charge. Essentially, the credit is a long-term interest-free loan from the government.
The ARRA increases the maximum homebuyer credit to $8,000 ($4,000 for married individuals filing separately) and extends the credit to purchases made before December 1, 2009. It also eliminates the repayment provision for residences purchased after December 31, 2008, as long as the property remains the taxpayer’s principal residence for three years after the date of purchase. For a residence purchased prior to December 1, 2009, the taxpayer can elect to treat the residence as if purchased on December 31, 2008 for purposes of claiming the credit on his or her 2008 tax return.
The credit phases out for taxpayers with modified adjusted gross income exceeding $75,000 ($150,000 for taxpayers filing jointly).
Temporary Increase of Refundable Portion of Child Tax Credit. Current law provides taxpayers with a $1,000 tax credit ($500 after 2010) for each qualifying child under age 17. (The credit phases out for taxpayers with modified adjusted gross income above specified amounts.) The credit is generally refundable to the extent of 15 percent of the taxpayer’s earned income exceeding a threshold amount, adjusted for inflation (this is referred to as the earned income formula). This threshold amount was set at $12,550 for 2009 under pre-ARRA law. The ARRA expands eligibility for this credit for 2009 and 2010 by modifying the earned income formula to apply to 15 percent of earned income in excess of $3,000. As a result, more low-income taxpayers will now be eligible for the credit.
Deduction for State Sales and Excise Tax on Certain Motor Vehicle Purchases. The ARRA allows taxpayers to deduct qualified motor vehicle taxes paid on purchases made after February 17, 2009 and before January 1, 2010. The deduction is available generally to taxpayers who itemize their deductions and also to those claiming the standard deduction. Qualified motor vehicle taxes are state or local sales or excise taxes imposed on the purchase of a passenger automobile, light truck (the gross vehicle weight rating of which does not exceed 8,500 pounds), motorcycle, or a motor home. The original use of the motor vehicle must begin with the taxpayer. The deduction is limited to the amount of taxes on up to $49,500 ($24,750 for married individuals filing separately) of the purchase price. The deduction is not available to taxpayers electing to claim an itemized deduction for state and local sales and use taxes, but the deduction is allowed in computing the AMT.
The deduction phases out for taxpayers with modified adjusted gross income between $125,000 and $135,000 ($250,000 and $260,000 for married individuals filing jointly).
Subsidy for Consolidated Omnibus Budget Reconciliation Act (COBRA) Continuation Coverage. COBRA provides that employees and their dependents whose coverage under a group health insurance plan has terminated must be allowed to elect to continue the coverage for at least 18 months by paying the full amount of the premium plus a small administrative fee. Under the ARRA, an individual whose employment has been involuntarily terminated is required to pay only 35 percent of the COBRA premium for up to nine months (or, if earlier, until the first of the month following the date the individual becomes eligible for coverage under any other group health plan (with some limited exceptions) or Medicare). The remaining 65 percent of the premium will be paid by the U.S. Department of the Treasury. To qualify for this “subsidized” coverage, an individual must have been involuntarily terminated from his or her employment between September 1, 2008 and December 31, 2009. An individual whose employment was involuntarily terminated between September 1, 2008 and February 17, 2009 (i.e., the date the ARRA was enacted), and who did not elect COBRA coverage because it was unaffordable, will be given an additional 60 days after notice from his or her employer to elect COBRA and receive the subsidy.
An individual whose modified adjusted gross income is in excess of $145,000 (or $290,000 for joint filers) is not eligible for the COBRA subsidy. An individual whose income is between $125,000 and $145,000 (or $250,000 and $290,000 for joint filers) is eligible for a partial subsidy. An individual whose income exceeds these limits in the year in which such individual receives the COBRA subsidy will have to repay the subsidy through a recapture tax on his or her income tax return.
Credits/Benefits That Do Not Phase Out Based on Income
Computer Technology and Equipment as a Qualified Expense for § 529 Plans in 2009 and 2010. A § 529 plan is an education savings program maintained by a state or eligible educational institution that allows a taxpayer to either (1) make contributions to prepay tuition by purchasing tuition credits for a designated beneficiary at current rates for future educational expenses or (2) contribute to an account that will be used to pay for qualified higher education expenses of a designated beneficiary. The earnings on contributions to a § 529 plan are not subject to federal income tax while funds are accumulated, and as long as the funds are distributed for qualified higher-education expenses, such distributions are not subject to tax on withdrawal. Qualified higher-education expenses include tuition, fees, books, supplies, and equipment required for the beneficiary’s enrollment or attendance at an eligible educational institution, expenses for special needs services, and expenses for room and board.
The ARRA expands the definition of qualified higher-education expenses to include expenses paid or incurred in 2009 or 2010 for computer technology, equipment, Internet access, and related services if such technology, equipment, or services are to be used by the § 529 plan beneficiary and his or her family during any of the years that the beneficiary is enrolled at an eligible educational institution. Thus, such expenses can be paid for from § 529 plan accounts in 2009 and 2010. Expenses for computer software designed for sports, games, or hobbies are excluded unless the software is predominantly educational in nature.
Suspension of Tax on Portion of Unemployment Compensation. Prior to enactment of the ARRA, any federal or state unemployment compensation benefits received were required to be included in the recipient’s gross income for federal income tax purposes. The ARRA excludes from an individual’s gross income for federal income tax purposes up to $2,400 of unemployment compensation benefits received in 2009.
Nonbusiness Energy Property Credit Extension. Pre-ARRA law allowed individuals to claim a tax credit for making certain energy-saving improvements to their homes (for example, installing new insulation designed to reduce heat loss/gain, new exterior windows and doors, or electric heat pumps and central air conditioners that meet certain energy standards). The ARRA extends this nonbusiness energy tax credit for one year through December 31, 2010 and increases the credit percentage from 10 percent to 30 percent of the amount paid or incurred by the taxpayer for qualified energy efficient improvements. The credit for energy efficient property purchases (such as purchases of heat pumps, water heaters, and central air conditioners) that under pre-ARRA law were subject to certain dollar limitations has been modified so that such purchases are instead eligible for a credit equal to 30 percent of the eligible expenditure. The ARRA also replaces the $500 lifetime cap on the credit ($200 lifetime cap for windows) with an aggregate $1,500 cap for property placed in service during 2009 and 2010.
New Qualified Plug-In Electric Vehicle Credit. Current tax law provides a credit for the purchase of certain battery-powered vehicles or “qualified plug-in electric drive motor vehicles.” For qualified plug-in electric drive motor vehicles purchased after December 31, 2009, the ARRA provides a maximum credit of up to $7,500 for all such vehicles. The credit phases out beginning in the second calendar quarter following the quarter in which a manufacturer, after December 31, 2009, sells its 200,000th plug-in electric drive motor vehicle for use in the United States. The credit is not subject to a termination date.
The ARRA also provides for a new nonrefundable tax credit equal to 10 percent of the cost of electric drive low-speed vehicles, motorcycles, and three-wheeled vehicles purchased after February 17, 2009 and before January 1, 2012. The maximum credit is $2,500. For a vehicle purchased after February 17, 2009 and before January 1, 2010, no such credit is allowed if the qualified plug-in electric drive motor vehicle credit discussed in the preceding paragraph is allowed for the vehicle.
Economic Recovery Payment to Social Security, Supplemental Security Income (SSI), and Railroad Retirement and Veterans Disability Compensation Benefits Recipients. The ARRA provides for a one-time $250 economic recovery payment to the following individuals: (1) adults eligible for Social Security benefits; (2) adults eligible for railroad retirement benefits; (3) adults eligible for veterans’ compensation or pension benefits; and (4) individuals of any age eligible for SSI benefits, other than individuals who receive SSI while in a Medicaid institution. An individual must have been eligible for one of these four programs for any of the three months prior to the month of the law’s enactment in order to receive the payment. In other words, an individual must have been eligible for one of the four benefit programs listed above for November 2008, December 2008, or January 2009 to be entitled to the $250 payment. An individual who receives benefits under more than one of the four programs listed above will be entitled to only one $250 payment. In addition, if an individual eligible for one of the four benefit programs also is eligible for the Making Work Pay credit, that credit will be reduced by the amount of any economic recovery payment made. The economic recovery payments are to begin as soon as practical, but no later than June 17, 2009. The payment is not included in a taxpayer’s gross income for income tax purposes.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and our colleagues.
If you have any questions about this issue or would like to discuss these topics further, please contact your Foley attorney or any of the following individuals:
Robert S. Bernstein
William C. Weinsheimer
John M. Lynham, Jr.
Erika A. Alley
James R. Spoor
Internal Revenue Service regulations generally require that, for purposes of avoiding United States federal tax penalties, a taxpayer may only rely on formal written opinions meeting specific requirements described in those regulations. This newsletter does not meet those requirements. To the extent this newsletter contains written information relating to United States federal tax issues, the written information is not intended or written to be used, and a taxpayer cannot use it, for the purpose of avoiding United States federal tax penalties, and it was not written to support the promotion or marketing of any transaction or matter discussed in the newsletter.