Major (And Expensive) Tax Changes in Stimulus Bill Explained
The American Recovery and Reinvestment Tax Act of 2009 makes over 300 changes to the Internal Revenue Code. Most changes are retroactive only to January 1, 2009, and affect primarily individual (vs. business) taxpayers. Practically none of the cuts benefit higher-income taxpayers. We explain who benefits, how much, and when.
President Obama’s desired stimulus plan is now law. The Congressional Budget Office estimated that the conference agreement plan will cost $787 billion. This consists of $281 billion in tax cuts (mostly for individuals), $308 billion of spending programs for “discretionary appropriations”, and $198 billion for benefit programs and assistance to states.
In total, the American Recovery and Reinvestment Tax Act of 2009 (the “Act”) makes over 300 changes to the Internal Revenue Code. With only one exception affecting few people (changes in business loss carryback rules), the tax cuts will not help you with your 2008 tax return or refund because none of the tax cuts affect your 2008 tax return. Most of the tax incentives are retroactive to January 1, 2009.
Practically none of the cuts benefit higher income taxpayers. Importantly, White House officials pledged to offer a plan to pay for the President's tax cut and new spending initiatives outside the stimulus package. This will occur when they unveil their budget proposal later this month. In addition to not providing affluent taxpayers any meaningful benefit under the Act, we predicted in our end-of-2008 tax planning suggestions that tax increases for the affluent would occur.
Here are the most expensive tax changes. With Congress spending nearly a trillion dollars at a whack, only those changes costing around a billion dollars or so made it to this article. Smaller changes are not summarized.
Individual Taxes and Benefits
1. Individual tax credits for earned income ($116.2 billion cost) – This is 40% of the total tax reduction. Those who make less than $75,000 a year (150,000 for couples) will pay less income tax. Individuals will get a $400 tax credit. Couples will receive twice that, or $800. Unlike President Bush’s 2008 tax stimulus/cuts, the IRS won't mail out rebate checks. Instead, withholding tables are being adjusted, thereby automatically boosting paychecks for those eligible. Starting in July 2009, wage earners will get about $15 per week extra in their paychecks. Starting in 2010, the same benefit will be spread out for the full year, reducing the per-week tax reduction in half, to about $7.50 per worker.
When you complete your tax return, this tax break takes the form of a refundable tax credit. “Refundable” means you can get a tax refund from this and other refundable tax breaks, even if no taxes are paid at all. This particular tax credit is calculated at 6.2 percent of earned income for those who do not have incomes over the phase-out limits specified above.
2. Extension of AMT relief for 2009 ($70 billion) - The Act provides more than 26 million families with tax relief in 2009 by increasing the Alternative Minimum Tax (AMT) exemption amount by $70,950 for joint filers and $46,700 for individuals. These amounts are a bit larger than the 2008 AMT exemption amounts.
3. Premium Subsidies for COBRA Continuation Coverage for Unemployed Workers ($24.7 billion) - The new law provides a 65% subsidy for COBRA continuation premiums for up to 9 months for workers who have been involuntarily terminated. To qualify for premium assistance, a worker must be involuntarily terminated between September 1, 2008 and December 31, 2009. The subsidy would terminate upon offer of any new employer-sponsored health care coverage or Medicare eligibility. Workers who were involuntarily terminated between September 1, 2008 and enactment, but failed to initially elect COBRA because it was unaffordable, would be given an additional 60 days to elect COBRA and receive the subsidy. Participants must attest that their same year income will not exceed $125,000 for individuals and $250,000 for families.
The former employer is required to pay the remaining 65% for the COBRA coverage. The former employer is then reimbursed the added cost through offsets against payroll taxes that would otherwise be paid to the federal government.
4. Increased Eligibility for the Refundable Child Credit ($14.8 billion) - The Act increases the eligibility for the $1,000-per-child refundable child tax credit in 2009 and 2010. For 2008, the child tax credit is refundable to the extent of 15 percent of the taxpayer’s earned income in excess of $8,500. The Act reduces the income floor to $3,000 in 2009 and 2010, from the current $8,500 floor. This means that one now needs only around $10,000 of income to obtain the full credit.
5. $250 one-time payment to retirees, veterans and the disabled ($14.4 billion) - The payroll tax credit described in #1 above goes to those who are employed. Recipients of (i) Social Security benefits, (ii) Railroad Retirement benefits, (iii) Supplemental Security Income payments, or (iv) Veterans' Administration pension and disability benefits will get one-time checks for $250. Government retirees who don't get checks from the federal government (e.g., social security) will get a one-time refundable tax credit of $250 in 2009.
6. Education Tax Credit ($13.9 billion) - The law provides financial assistance for individuals seeking a college education. For 2009 and 2010, the Act provides taxpayers with a new tax credit of up to $2,500 (up from the existing $1,800 HOPE credits) of the cost of tuition and related expenses paid during the taxable year. Under this new tax credit, taxpayers will receive a tax credit based on 100% of the first $2,000 of tuition and related expenses (including books) paid during the taxable year and 25% of the next $2,000 of tuition and related expenses paid during the taxable year. 40% of this qualifies as a refundable tax credit. This tax credit will be subject to a phase-out for taxpayers with adjusted gross income in excess of $80,000 ($160,000 for married couples filing jointly).
7. First-time Home Buyer Credit. ($6.6 billion) - Last year, Congress provided taxpayers with a refundable tax credit that was equivalent to an interest-free loan equal to 10 percent of the purchase of a home (up to $7,500) by first-time home buyers. Taxpayers receiving this tax credit based on a 2008 purchase were required to repay any amount received back to the government when the home is sold, with 15 yearly equal installments while the home is still owned. The credit phases out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return).
The Act eliminates the repayment obligation for taxpayers purchasing homes after January 1, 2009 (the escrow closing date is the purchase date) and increases the maximum value of the credit to $8,000. The provision would retain the credit recapture if the house is sold within three years of purchase.
8. Increase in the Earned Income Tax Credit ($4.7 billion) - Under current law, working families with two or more children currently qualify for an earned income tax credit equal to 40% of the family’s first $12,570 of earned income, or $5,028. This credit is subject to a phase-out for working families with adjusted gross income in excess of $16,420 ($19,540 for married couples filing jointly). The Act increases the earned income tax credit to 45% of the family’s first $12,570 of earned income, or $5,656, but only for families with three or more children. The law also increases the beginning point of the phase-out range for all married couples filing a joint return (regardless of the number of children) by $1,880.
9. Taxation of unemployment benefits (4.7 billion) - Under current law, all federal unemployment benefits are subject to taxation. The Act temporarily suspends, for 2009 only, federal income tax on the first $2,400 of unemployment benefits per recipient. Any unemployment benefits over $2,400 will be subject to federal income tax.
10. Sales Tax Deduction for Vehicle Purchases ($1.7 billion) - The Act provides all taxpayers with a deduction for State and local sales and excise taxes paid on the purchase of new cars, light truck, recreational vehicles, and motorcycles through 2009, regardless of whether deductions are itemized (i.e., an above-the-line deduction). This deduction is subject to a phase-out for taxpayers with adjusted gross income in excess of $125,000 ($250,000 in the case of a joint return). The sales tax deduction is limited to the first $49,500 of purchase price, and (unlike many of the Act’s retroactive provisions) is effective on February 16, 2009 when President Obama signed the Act.
Business Taxes and Other Major Changes
1. Repeal of Treasury Section 382 Notice (Increases $7.0 billion of taxes) - Last year, the Treasury Department issued Notice 2008-83, which liberalized rules involving Internal Revenue Code Section 382. Section 382 limits the use of an acquired company’s net operating loss (NOL) by the acquiring taxpayer after the change in control. The apparent policy reason behind Treasury’s controversial change was to encourage acquisitions of weak financial institutions by stronger banks. The Act repeals Notice 2008-83 prospectively.
2. Extension of Bonus Depreciation ($5.1 billion) - Businesses are allowed to recover the cost of capital expenditures over time according to a depreciation schedule. Last year, Congress temporarily allowed businesses to recover the costs of capital expenditures made in 2008 faster than the ordinary depreciation schedule would allow by permitting these businesses to immediately write-off fifty percent of the cost of certain equipment acquired in 2008 for use in the United States. The Act would extend this temporary benefit for capital expenditures incurred in 2009.
3. Delayed Recognition of Certain Cancellation of Debt Income (1.6 billion) - Under current law, a taxpayer generally has income where the taxpayer cancels or repurchases its debt for an amount less than its adjusted issue price. The amount of cancellation of debt income (CODI) is the excess of the old debt’s adjusted issue price over the repurchase price. Certain businesses will be allowed to recognize CODI over 10 years (defer tax on CODI for the first four or five years and recognize this income ratably over the following five taxable years) for specified types of business debt repurchased by the business after December 31, 2008 and before January 1, 2011.
4. 5-year Carryback of Net Operating Losses for Small Business ($947 million) – Under current law, NOLs may be carried back two taxable years before the loss occurs, and carried forward for the succeeding twenty years. For 2008, the Act extends the maximum NOL carryback period from two to five years, but only for businesses with $15 million or less in gross receipts.
A number of changes affect incentives to invest in renewable energy. The Act (i) extends tax breaks for wind facilities and other renewable energy facilities, and provides other tax incentives to encourage development of renewable energy facilities, (ii) authorizes additional new clean renewable energy bonds and energy conservation bonds to finance state and local government projects to reduce greenhouse gas emissions, (iii) extends tax credits for energy-efficient improvements to existing homes, (iv) provides a tax credit for purchase of "plug-in" electric vehicles of at least $2,500, and (v) provides a new 30 percent investment tax credit for facilities engaged in producing renewable energy technology and conservation. Discussion of these matters is beyond the scope of this article.
The Act makes changes to public financing (municipal bonds) to assist state and local governments. Generally, the Act (i) creates a new category of tax-preferred bonds for investment in economic recovery zones for job training, education and economic development, (ii) creates a new category of tax-preferred bonds for the construction and repair of public schools, and the purchase of land for schools, and (iii) creates a federal subsidy for state and local governments offering bonds that give investors credits against their federal taxes in place of interest payments.
Discussion of these matters is also beyond the scope of this article.
Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials: CPA, MBA, CMA and ASA.
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Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.