President Signs Tax Bill of Extenders and More
Christmas came days early to Washington as Congress passed with uncharacteristic bipartisan cooperation the $1.1 trillion Omnibus Appropriations Act, 2016 (the “Act”), which included the “Protecting Americans from Tax Hikes Act of 2015” (“PATH”), a substantially unfunded $680 billion tax cut over 10 years. The Act was signed into law by President Obama on December 18, 2015 (the “date of enactment”). How these tax law changes with reduced revenue will impact longer term tax reform efforts as well as future federal government spending is an interesting question that bears watching.
The PATH legislation, covering some 233 pages of legislative text, extends many provisions of existing law permanently or, in certain cases, for a number of years. Following are the tax highlights of the Act, including the PATH legislation.
Enhanced child tax credit. The child tax credit (“CTC”) is a $1,000 credit for each qualifying child under the age of 17, subject to phase-out for individuals with income over certain amounts. To the extent that the CTC exceeds the taxpayer’s tax liability, the taxpayer is eligible for a refundable credit (“the additional child tax credit”) equal to 15% of earned income in excess of a threshold dollar amount. For taxable years 2009-2017, the threshold is currently $3,000. Families with 3 or more qualifying children may determine the additional child tax credit using an alternative formula. The earned income threshold of $3,000 is made permanent by PATH, effective for tax years beginning after the date of enactment.
Enhanced American Opportunity Tax credit. The American Opportunity Tax Credit (“AOTC”), which is a modified Hope Scholarship Credit, is available to individuals who incur tuition and related expenses (i.e., course materials) for post-secondary education. The AOTC allows a maximum credit of $2,500 per year for 4 years of post-secondary education. The credit is phased-out ratably for taxpayers with modified adjusted gross income (“AGI”) between $80,000 and $90,000 ($160,000 and $180,000 for married taxpayers filing jointly). Generally, 40% of the otherwise allowable credit is refundable, though it is not refundable if the taxpayer claiming the credit is subject to the “kiddie tax” and other limitations. Scheduled to expire for taxable years after 2017, the AOTC is made permanent by PATH.
Enhanced earned income tax credit. Low- and moderate-income workers may be eligible for the refundable earned income tax credit (“EITC”). For 2009 to 2017, the EITC amount had been temporarily increased for those with 3 or more children, and the EITC “marriage penalty” had been reduced by increasing the income phase-out range by $5,000 (indexed for inflation) for those who are married and filing jointly. PATH makes this section permanent.
Extension of parity for exclusion from income for employer-provided mass transit and parking benefits. PATH reinstates parity in the exclusion for combined employer-provided transit pass and vanpool benefits and for employer-provided parking benefits, for months after December 31, 2014. These fringe benefits are excluded from an employee’s wages for payroll tax purposes and from gross income for income tax purposes. Prior to PATH, as of January 1, 2015, the amount that could be excluded was limited to $130 per month in combined transit pass and vanpool benefits and $250 per month in parking benefits. As a result of PATH, for 2015, the monthly limit on the exclusion for combined transit pass and vanpool benefits is now $250, the same as the monthly limit on the exclusion for qualified parking benefits. For 2016, the monthly exclusion limit both for combined transit pass and vanpool benefits and for employer-provided parking benefits increases to $255.
Extension of deduction of state and local general sales taxes. PATH permanently extends the option to claim an itemized deduction for state and local general sales tax in lieu of an itemized deduction for state and local income taxes, effective for taxable years beginning after December 31, 2014. A taxpayer may either deduct the actual amount of sales tax paid in the tax year or, alternatively, deduct an amount prescribed by the IRS.
Extension of special rule for contributions of capital gain real property made for conservation purposes. Under a temporary provision that terminated for contributions made in taxable years beginning after December 31, 2014, the 30% contribution base limitation on deductions for contributions of capital gain property by individuals did not apply to “qualified conservation contributions.” A qualified conservation contribution is a contribution of a “qualified real property interest” to a qualified organization exclusively for conservation purposes. Instead, individuals could deduct the fair market value of any qualified conservation contribution to the extent of the excess of 50%of the contribution base over the amount of all other allowable charitable contributions. These contributions were not taken into account in determining the amount of other allowable contributions. Individuals were allowed to carry over any qualified conservation contributions that exceeded the 50% limitation for up to 5 years. PATH reinstates and makes permanent the increased percentage limits and extended carryforward period for qualified conservation contributions for contributions made in taxable years beginning after December 31, 2014.
Extension of tax-free distributions from individual retirement plans for charitable purposes. PATH permanently extends the ability of individuals at least 70½ years of age to exclude from gross income qualified charitable distributions (not exceeding $100,000 per taxpayer in any tax year) from individual retirement accounts (“IRAs”). This provision is effective for distributions made in taxable years beginning after December 31, 2014.
Extension and modification of research credit. The research and development R&D tax credit, which expired for amounts paid or incurred after December 31, 2014, is reinstated and made permanent for amounts paid or incurred after December 31, 2014. In addition, for taxable years beginning after December 31, 2015, eligible small businesses ($50 million or less in gross receipts) may claim the credit against alternative minimum tax (“AMT”) liability, and the credit can be utilized by certain small businesses against the employer’s payroll tax (i.e., FICA) liability.
Extension and modification of increased expensing limitations and treatment of certain real property as IRC Section 179 property. Under current law, a taxpayer may elect under IRC Sec. 179 to expense the cost of “qualifying property,” rather than to recover such costs through depreciation deductions, subject to limitation. For taxable years beginning in 2014, the maximum amount a taxpayer could expense was $500,000 of the cost of qualifying property placed in service for the taxable year. The $500,000 amount was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeded $2,000,000. The $500,000 and $2,000,000 amounts were not indexed for inflation. In general, qualifying property is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or business. Prior to PATH, for taxable years beginning in 2015 and thereafter, these amounts had been reduced to $25,000 and $200,000 respectively. Effective for tax years beginning after December 31, 2014, PATH permanently extends the small business expensing limitation and phase-out amounts to the 2014 level, indexes them for inflation for taxable years beginning after 2015 and treats air conditioning and heating units placed in service in tax years beginning after 2015 as eligible for expensing. Special rules that allowed expensing for computer software and qualified real property (i.e., qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property) prior to 2015 are permanently extended. Also, PATH modifies an expensing limitation with respect to qualified real property by eliminating, beginning in 2016, a previously existing $250,000 cap.
Extension of exclusion of 100% of gain on certain small business stock (IRC Sec. 1202). PATH permanently extends, for stock acquired after December 31, 2014, the temporary exclusion of 100% of the gain on the sale by non-corporate taxpayers of certain small business stock acquired at issue and held for more than 5 years. Also permanently extended is the rule that eliminates that gain as an AMT item of tax preference.
Extension of reduction in S corporation recognition period for built-in gains. PATH permanently extends the rule reducing to 5 years (rather than 10 years) the period for which an S corporation must hold it assets following conversion from a C corporation to avoid the tax on built-in gains. In general, a corporate level built-in gains tax, at the highest marginal rate applicable to corporations (currently 35%), is imposed on an S corporation’s net recognized built-in gain that arose prior to the conversion of the C corporation to an S corporation and is recognized by the S corporation during the recognition period.
Extension of subpart F exception for active financing income. PATH makes permanent the temporary exceptions from subpart F foreign personal holding company income, foreign base company services income, and insurance income for certain income that is derived in the active conduct of a banking, financing or similar business; as a securities dealer; or in the conduct of an insurance business. This provision is effective for taxable years of foreign corporations after December 31, 2014, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.
Extensions Through 2019
Extension and modification of work opportunity tax credit. PATH extends the work opportunity tax credit through taxable years beginning on or before December 31, 2019. PATH also extends the credit beginning in 2016 to apply to employers who hire qualified long-term unemployed individuals (i.e., those who have been unemployed for 27 weeks or more).
Extension and modification of bonus depreciation. The provision extends bonus depreciation for property acquired and placed in service during 2015 through 2019 (with an additional year for certain property with a longer production period). The bonus depreciation percentage is 50% for property placed in service during 2015, 2016 and 2017 and phases down, with 40% in 2018 and 30% in 2019. Taxpayers can continue to elect to accelerate the use of AMT credits in lieu of bonus depreciation under special rules for property placed in service in 2015. The provision modifies the AMT rules beginning in 2016 by increasing the amount of unused AMT credits that may be claimed in lieu of bonus depreciation.
Extensions Through 2016
Extension of above-the-line deduction for qualified tuition and related expenses. PATH extends for 2 years, through 2016, the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for an individual whose adjusted gross income does not exceed $65,000 ($130,000 in the case of a joint return) or $2,000 for an individual whose adjusted gross income does not exceed $80,000 ($160,000 for joint filers). No deduction is allowed for an individual whose adjusted gross income exceeds the applicable limitation, for a married individual who does not file a joint return, or for an individual with respect to whom a personal exemption deduction may be claimed by another taxpayer for the taxable year.
Extension and modification of credit for nonbusiness energy property. PATH extends through December 31, 2016 the credit for purchases of nonbusiness energy property. The provision allows a credit of 10% of the amount paid or incurred by the taxpayer for qualified energy improvements, up to $500.
Extension and modification of exclusion from gross income of discharge of qualified principal residence indebtedness. PATH extends for 2 years (through December 31, 2016) the exclusion from gross income of a discharge of “qualified principal residence indebtedness.” In general, qualified principal residence indebtedness for this purpose is indebtedness (up to $2,000,000, $1,000,000 in the case of a married individual filing a separate return) incurred in the acquisition, construction or substantial improvement of the principal residence of an individual, secured by the residence. It also includes refinancing of that indebtedness to the extent the amount of the indebtedness resulting from the refinancing does not exceed the amount of the refinanced indebtedness. This provision also provides for an exclusion from gross income in the case of those taxpayers whose qualified principal residence indebtedness is discharged on or after January 1, 2017, if the discharge is pursuant to a binding written agreement entered into prior to January 1, 2017.
Extension of mortgage insurance premiums treated as qualified residence interest. PATH extends through 2016 the treatment of qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. This deduction phases out ratably for a taxpayer with AGI of $100,000 to $110,000.
Moratorium on medical device excise tax. PATH provides for a 2-year moratorium on the 2.3% excise tax on the sale of medical devices. The tax will not apply to sales during calendar years 2016 and 2017.
Modification of filing dates of returns and statements relating to employee wage information and nonemployee compensation. PATH requires forms W-2, W-3, and returns or statements to report non-employee compensation (e.g., Form 1099-MISC), to be filed on or before January 31 of the year following the calendar year to which such returns relate. The provision is effective for returns and statements relating to calendar years beginning after the date of enactment.
Improvements to section 529 accounts. A qualified tuition program is a program established and maintained by a state or agency or instrumentality, or by one or more eligible education institutions, which satisfies certain requirements and under which a person may purchase tuition credits or certificates on behalf of a designated beneficiary that entitle the beneficiary to the waiver or payment of qualified higher education expenses of the beneficiary. IRC Sec. 529 provides specified income and transfer tax rules for the treatment of accounts and contracts established under qualified tuition programs. PATH expands the definition of qualified higher educational expenses for which tax preferred distributions from section 529 accounts are eligible to include computer equipment and technology. The provision modifies section 529 account rules to treat any distribution from a section 529 account as coming only from that account (rather than aggregating), even if the individual making the distribution operates more than one account. Also, the provision treats a refund of tuition paid with amounts distributed from a section 529 account as a qualified expense if those amounts are re-contributed to a section 529 account within 60 days. The provision is effective for distributions made or refunds after 2014, or, in the case of refunds after 2014 and before the date of enactment, for refunds re-contributed not later than 60 days after the date of enactment.
Rollovers permitted from other retirement plans into SIMPLE retirement accounts. Certain small businesses can establish a simplified retirement plan called a “savings incentive match plan for employees” (“SIMPLE”) retirement plan. SIMPLE plans can be adopted by employers that: (1) employ 100 or fewer employees who received at least $5,000 in compensation during the preceding year, and (2) do not maintain another employer-sponsored plan. A SIMPLE plan can be either an individual retirement arrangement (an IRA) for each employee or part of a qualified cash or deferred arrangement (a section 401(k) plan). PATH allows a taxpayer to roll over amounts from an employer sponsored retirement plan (e.g., a 401(k) plan) to a SIMPLE IRA, provided the plan has existed for at least 2 years. The provision applies to contributions made after the date of enactment.
Significant modification of REIT rules. Some 15 provisions of PATH specifically address a variety of technical and policy considerations of real estate investment trusts (REITs). One in particular should be noted, and that deals with tax-free spinoffs involving REITs, undoubtedly as a result of high-profile tax-free spinoffs involving REITs that have closed or are being considered. To counteract the use of spinoffs in a REIT context, this provision provides that a spinoff involving a REIT will qualify as tax-free only if immediately after the distribution both the distributing and the controlled corporation are REITs. In addition, neither a distributing nor controlled corporation in a tax-free spinoff transaction that is not a REIT is permitted to elect to be treated as a REIT for 10 years following the tax-free spinoff. This provision applies to distributions made on or after December 7, 2015, but will not apply to any distribution pursuant to a transaction described in a ruling request initially submitted to the IRS on or before that date, which request has not been withdrawn and with respect to which a ruling has not been issued or denied in its entirety as of such date. (Accordingly, a number of significant transactions that have been announced but not completed will in fact be grandfathered.)
Exception from FIRPTA for interest held by foreign retirement or pension funds. PATH exempts any U.S. real property interest held by a foreign retirement or pension fund from FIRPTA withholding, effective for dispositions and distributions after the date of enactment.
Increase in rate of withholding of tax on dispositions of U.S. real property interests. PATH increases the rate of withholding of tax on dispositions and certain dispositions of U.S. real property interests from 10% to 15%. The increased rate of withholding does not apply to the sale of a personal residence where the amount realized is $1,000,000 or less. This provision applies to dispositions after the date which is 60 days after the date of enactment.
Modification of rules governing small captive insurance companies.Small captive insurance companies have been the subject of much attention by oftentimes aggressive promoters and the IRS alike over recent years . PATH attempts to encourage the legitimate use of small captive insurance companies while making efforts to ensure that the rules are not abused. On one hand, PATH increases the maximum amount of annual premiums that such insurance companies can receive and still be exempt from tax on their underwriting income and instead be taxed only on taxable investment income. That maximum amount is increased from $1.2 million to $2.2 million for calendar years beginning after 2015, and is indexed to inflation thereafter. In addition, PATH adds diversification requirements to the eligibility rules, that can be met in one of two ways: (1) a risk diversification test -- no more than 20% of the net written premiums (or, if greater, direct written premiums) of the company for the taxable year is attributable to any one policyholder (all policyholders that are related or are members of the same controlled group are treated as one policyholder); or (2) a relatedness test -- if the 20% requirement is not satisfied, no person who holds (directly or indirectly) an interest in the insurance company is a “specified holder” who holds (directly or indirectly) aggregate interests in the insurance company that constitute a percentage of the entire interests in the insurance company that is more than a de minimis percentage higher than the percentage of interests in the trades or businesses being insured that are directly or indirectly held by the specified holder. Except as provided in regulations or other guidance, 2 percentage points or less is treated as de minimis. A specified holder, with respect to an insurance company, is defined as any individual who holds (directly or indirectly) an interest in the insurance company and who is a spouse or lineal descendant of an individual who holds an interest (directly or indirectly) in the trade or business or assets being insured. Any insurance company for which a small captive insurance election is in effect for a taxable year must report information required by the IRS relating to the new diversification requirement. The small captive insurance rules are effective for years beginning after December 31, 2016.
Prevention of transfer of certain losses from tax indifferent parties. The Internal Revenue Code related-party rules, which generally disallow a deduction for a loss on the sale or exchange of property to certain related parties or controlled partnerships, are modified by PATH to prevent losses from being shifted from a tax-indifferent party (e.g., a foreign person not subject to U.S. tax) to another party in whose hands any gain or loss with respect to the property would be subject to U.S. tax. This provision generally is effective for sales and exchanges of property acquired after December 31, 2015.
Gift tax not to apply to contributions to certain exempt organizations. Effective for transfers made after the date of enactment, the gift tax will not apply to the transfer of money or other property to a tax-exempt organization described in IRC Sec. 501(c)(4) (generally, social welfare organizations), IRC Sec. 501(c)(5) (generally, labor and certain other organizations) or IRC Sec. 501(c)(6) (generally, trade associations and business leagues).
Partnership audit rules. PATH corrects and clarifies a number of technical issues in the recently enacted Bipartisan Budget Act of 2015, including (1) modifying an imputed underpayment based on applicable highest tax rates, (2) modifying an imputed underpayment based on certain passive losses of publicly traded partnerships, (3) the limitations period for making partnership adjustments, and (4) the forum for judicial review.
Delay of Cadillac Tax. The Act delays the commencement of the Patient Protection and Affordable Care Act’s so-called “Cadillac Tax” by 2 years, to tax years beginning after December 31, 2019, and makes the tax deductible against other income. This controversial excise tax, a 40% levy on coverage providers, was to apply to the extent that the cost of health policies provided exceeded $10,200 in the case of single coverage and $27,500 in the case of non-single (e.g., family) coverage, with the thresholds indexed for inflation in subsequent years.