Economic Stabilization Legislation

November 5th, 2008

On October 3, 2008, Congress passed and the President signed into law the “Economic Stabilization” legislation, which included numerous tax law changes that are mostly pro-taxpayer. These changes will impact just about everyone, and you are encouraged to review them below. Please call this office if you have questions about any of the provisions or need additional details.

Additional Standard Deduction for State and Local Property Taxes – The tax provision that allows taxpayers who claim the standard deduction instead of itemizing deductions to claim an additional standard deduction for State and local property taxes paid, originally slated for 2008 only, has been extended through 2009. The deduction cannot exceed the lesser of state and local property taxes actually paid or $500 ($1,000 for joint return filers). No taxes deductible in computing adjusted gross income are taken into account in computing the increased standard deduction.

Refundable Child Tax Credit Eased – Currently, taxpayers receive a $1,000 tax credit for each child under the age of 17. The credit is used to reduce the taxpayer’s tax liability. If the credit is larger than the tax liability, the excess is eligible for a refundable credit called the “additional child tax credit.” The additional child tax credit is equal to 15% of earned income in excess of a threshold dollar amount. For 2008, the threshold amount has been reduced to $8,500 from $12,050, thus increasing the refundable amount for low-income taxpayers.

Income Averaging for Exxon Valdez Litigation Amounts – Effective October 3, 2008, commercial fishermen and other individuals whose livelihoods were negatively impacted by the ’89 Exxon Valdez oil spill are allowed to average any settlement or judgment-related income that they receive in connection with pending litigation in the federal courts over three years for federal tax purposes. It also allows them to use these funds to make contributions to retirement accounts.

Qualifying Child – The “uniform definition of a child” is used in taxes to determine when an individual qualifies for certain tax benefits including the dependency exemption, child tax credit and earned income tax credit. Acting to close some of the loopholes in various applications of the uniform definition of a child, Congress has made several changes to the qualifying child rules effective beginning in 2009. The new law:

• Requires that a qualifying child be younger than the claimant;

• Requires that a qualifying child be unmarried;

• Restricts qualifying child tax benefits to the child’s parents in certain cases; and

• Denies the child tax credit to taxpayers who are dependents.

Home Mortgage Debt Forgiveness Relief – When a taxpayer defaults on their home loan through foreclosure, short sale or voluntary reconveyance, the amount of the debt forgiven becomes income for tax purposes. Thus, a taxpayer who has just lost their home is also straddled with an additional tax burden created by the debt relief income. Trying to soften the foreclosure problems, Congress, last year, added a provision that allows taxpayers to exclude up to $2 million ($1 million for married individuals filing separately) of home mortgage acquisition debt relief income from a taxpayer’s principal residence. This provision has been extended through 2012.

Deduction for State and Local Sales Taxes – The provision whereby a taxpayer may elect to claim an itemized deduction for state and local general sales taxes instead of deducting state and local income taxes has been retroactively reinstated for 2008 and extended through 2009.

Deduction of Qualified Tuition & Related Expenses –The above-the-line deduction for qualified tuition and related expenses has been retroactively reinstated for 2008 and extended through 2009. This provision allows a taxpayer to claim an above-the-line deduction for qualified tuition and related expenses for higher (post-secondary) education. The maximum deduction is $4,000 for an individual whose adjusted gross income (AGI) for the tax year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other individuals whose AGI does not exceed $80,000 ($160,000 in the case of a joint return). No deduction is allowed for an individual whose AGI exceeds the relevant AGI limits, for a married individual who does not file a joint return, or for an individual whose personal exemption deduction may be claimed by another taxpayer for the tax year.

Educator Above-the-Line Expenses – The above-the-line deduction for teachers (kindergarten through 12th grade) has been retroactively reinstated for 2008 and extended through 2009. Eligible teachers may claim an above-the-line deduction for up to $250 annually of expenses paid or incurred for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used by the eligible educator in the classroom. To be eligible for this deduction, the expenses must be otherwise deductible as a trade or business expense.

Tax-Free IRA to Charity Distributions – The provision that permits taxpayers age 70½ and over to make direct distributions (up to $100,000) from their IRA account to a charity has been reinstated for 2008 and 2009. The distribution is tax-free, but there is no charitable deduction. This provision can be very beneficial to taxpayers who have social security income and/or do not itemize their deductions.

IMPORTANT: You must act quickly to take advantage of this provision for 2008.  If you are over 70½ and are contemplating any size of cash charitable contribution between now and the end of the year, please call to see if making a direct contribution from your IRA can provide you any significant tax benefit for 2008.

Alternative Minimum Tax Relief – For yet another year, Congress has applied a patch to the AMT by increasing the AMT exemption amount and continuing to allow nonrefundable credits, such as dependent care, child credit, education credits and others that most middle-income taxpayers use to avoid this punitive tax. In addition, the amount of long-term unused AMT tax credit that can be applied in the current year was also substantially increased. The following is an overview of these changes:

AMT Exemption Amount for 2008 Increased – The AMT exemptions have been increased for 2008 to: $69,950 for married individuals filing jointly, $46,200 for unmarried individuals and $34,975 for married individuals filing separately. The AMT phase-out rules remain unchanged.

AMT Relief for Nonrefundable Personal Credits – Nonrefundable personal credits will offset the AMT for 2008. Those credits include the dependent care credit, elderly and disabled credit, Hope and Lifetime Learning credits, adoption credit, child tax credit, mortgage credit, saver’s credit and certain residential and home energy credits.

Increased AMT Refundable Long-Term Unused Credits – Prior to this change and for purposes of claiming the long-term unused minimum tax credit, the refundable credit amount was limited to the greatest of (1) $5,000, (2) 20% of the long-term carryover or (3) the AMT refundable credit amount (if any) for the prior year – before any reduction by reason of AGI. Under the Act, the $5,000 limitation has been removed, and the 20% limit has been increased to 50%.

In addition, the Act provides for abatement of any underpayment of tax outstanding on October 3, 2008, which is attributable to AMT on incentive stock options for any taxable year ending before January 1, 2008. The abatement extends to any related interest or penalty.

Home Energy Credit – The credit for certain energy-efficient property installed on the taxpayer’s principal residence that originally expired in 2007 has been reinstated for 2009 only. This provision allows a nonrefundable $500 credit for the installation of qualified windows, skylights, air circulation systems, hot water boilers and other energy-efficient equipment. Biomass fuel stoves that heat the residence or heat water for the residence, and asphalt roofs which include appropriate cooling granuals have been added to the list of qualifying property.

Residential Energy-Efficient Property (REEP) Credit – This credit, which was scheduled to expire after 2008, has been extended through 2016 and includes credit for the installation of solar water heating systems (excluding swimming pools) and qualified fuel cell property. The $2,000 cap on the solar systems credit is removed as of 2009, wind property and geothermal heat pumps are eligible as of 2008, and the credit can now be claimed against the AMT.

Certain Farming Machinery & Equipment Treated as 5-Year Property – For 2009 only, new machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) which is used in a farming business after December 31, 2008, and which is placed in service before January 1, 2010, is treated as 5-year property.

Plug-In Electric Drive Vehicle Credit – A tax credit for “new qualified plug-in electric drive motor vehicles” purchased before January 1, 2015 has been added. The credit, which is subject to a limit based on weight, is the sum of: (1) $2,500 plus (2) $417 for each kilowatt hour of traction battery capacity in excess of 6 kilowatt hours. The maximum credit for vehicles weighing 10,000 pounds or less is $7,500. Larger maximums apply to heavier vehicles. When the vehicle is used partially for business, the credit is allocated between personal and business credits. This credit has a phase-out provision similar to the hybrid vehicle credit and will begin to phase out after 250,000 units are sold. Watch for more on this when the vehicles become available.

Bicycle Reimbursements Added to Employer Fringe Benefits – Employers are able to provide certain tax-free “fringe benefits” to their employees. “Qualified bicycle commuting reimbursement” has been added to the list of qualified transportation fringe benefits. Up to $20 per month of employer tax-free reimbursement is allowed for reasonable expenses incurred by the employee during that calendar year for the purchase of a bicycle and bicycle improvements, repair and storage if the bicycle is regularly used for travel between the employee’s residence and place of employment.

Contractor Efficient Home Credit – An eligible contractor may claim a business credit for each qualified new energy-efficient home that the contractor constructs and which is acquired by a person from the contractor for use as a residence. The credit is either $2,000 (for a 50% energy reduction in energy usage) or $1,000 (for a 30% energy reduction in energy usage). This credit has been extended through 2009.

Energy-Efficient Commercial Building Property – A deduction is allowed in an amount equal to the cost of “energy-efficient commercial building property” placed in service during the tax year. The maximum deduction for any building for any tax year is the excess (if any) of $1.80 multiplied by the square footage of the building, less the aggregate amount of the deduction for the building for all earlier tax years. This credit is extended through 2013.

Casualty Losses – The $100 floor for personal-use property has been increased to $500 for 2009 only. The 10% of AGI limit on personal casualty losses is waived in federally declared disasters in 2008 and 2009. The 2008 Extenders Act introduces the new definition of a “federally declared disaster,” allows certain casualty losses to be tacked on to the standard deduction, and modifies provisions related to federally declared disaster areas.

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