Emergency Economic Stabilization Act of 2008 Tax Changes Affecting Individuals

On Oct. 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (P.L. 110-343). Although virtually all of the press coverage of this law has concentrated on its hotly debated $700 billion financial industry bailout plan, the legislation also contains scores of tax changes, mostly beneficial, for individuals and businesses alike.

Here is a review of the major tax provisions:

AMT relief: In general terms, to find out if you owe alternative minimum tax (AMT), regular taxable income is modified with various adjustments and preferences (such as addbacks for property and income tax deductions and dependency exemptions), and then subtract an exemption amount (which phases out at higher levels of income). The result is multiplied by an AMT tax rate of 26% or 28% to arrive at the tentative minimum tax. AMT is paid only if the tentative minimum tax exceeds your regular tax bill. Although it was originally enacted to make sure that wealthy individuals did not escape paying taxes, the AMT has wound up ensnaring many middle-income taxpayers. One reason is that many of the tax figures (such as the tax brackets, standard deductions, and personal exemptions) used to arrive at the regular tax bill are adjusted for inflation, but the tax figures used to arrive at the AMT are not.

For 2008 only, the new law provides some relief. It increases the maximum AMT exemption amount over to $69,950 for married taxpayers filing joint returns and surviving spouses, to $46,200 for single individuals and head of households and to $34,975 for married couples filing separately. However, after 2008 the maximum AMT exemption amount will drop precipitously to where it was in the year 2000 unless Congress provides yet another fix.

Another provision in the new law provides AMT relief for those individuals claiming certain "nonrefundable" personal tax credits (such as the credit for dependent care and the Scholarship and Lifetime Learning credits). For 2008, these credits may offset an individual's regular tax and AMT. After 2008, unless Congress acts, these credits will be allowed only to the extent that an individual has regular income tax liability in excess of the tentative minimum tax.

The new law also liberalized the AMT refundable credit amount that was first enacted in 2006 to help taxpayers who were stung by the AMT as a result of exercising incentive stock options (ISOs). The changes are highly technical but their essence is that for tax years beginning after 2007: (1) eligible individuals may claim this credit more rapidly (i.e., over fewer years) than would have been the case without the change; and (2) the AMT refundable credit amount no longer phases out at higher levels of adjusted gross income (AGI). In addition, the new law wipes out any tax underpayments (plus interest & penalties) outstanding on Oct. 3, 2008, that are attributable to pre-2008 phantom ISO income under the AMT rules.

Retroactively resuscitated and extended tax breaks: All of the following tax breaks had expired at the end of last year. The new law retroactively resuscitates them so that they apply for 2008, and also extends them for one year so that they will apply for 2009 as well:

The option to claim an itemized deduction for state and local general sales taxes instead of the itemized deduction for state and local income taxes.

The above-the-line deduction for qualified tuition and related expenses for higher education paid during the tax year.

The up-to-$250 eligible educator's above-the-line deduction for books, supplies, computer equipment, etc., used by him or her in the classroom.

The up-to-$100,000 annual exclusion from gross income for taxpayers age 70 1/2 or older who make direct transfers of otherwise taxable individual retirement account (IRA) distributions to qualified charitable organizations.

The new law also extends for one year the nonitemizers' additional standard deduction for State and local property taxes paid. The deduction can't exceed the lesser of state and local property taxes actually paid or $500 ($1,000 for joint return filers). This deduction was supposed to have been available only for 2008, but the new law makes it available for 2009 as well.

Deductions for energy saving home improvements extended and expanded: Two tax credits are available for taxpayers who make energy saving improvements to residences. They've both been extended by the new law and expanded as well:

(1) A generous tax credit is available to individuals who add solar energy equipment or fuel-cell equipment (new technology that converts fuel into electricity using electromechanical methods, and meets other detailed requirements) to their residences. The new law extends this credit through 2016. It also liberalizes the credit in an important way: For 2008, a tax credit of 30% of the cost of equipment that uses solar energy to generate electricity (photovoltaic property), up to a $2,000 maximum tax credit can be claimed. After 2008, there's no dollar limitation on the credit. For example, suppose you spend $8,000 buying and installing solar heating panels on your residence. If you make the improvement this year, you may claim a maximum credit of $2,000, but if you make the improvement next year, you may claim a credit of $2,400 (30% of $8,000).

Additionally, starting with 2008, the new law makes the credit available for more-exotic energy generating/retaining equipment: wind turbines; and geothermal heat pumps.

(2) For equipment installed before 2008, a credit could be claimed for the cost of buying an assortment of energy saving improvements and installing them in your main home. The credit depends on the type of improvement (e.g., 10% of the cost of energy efficient building envelope components, such as insulation and windows, and an up to $150 credit for a natural gas, propane, or oil furnace or hot water boiler) and there's an overall $500 lifetime dollar limit for all improvements.

The new law does not extend this credit for qualifying equipment bought and installed in 2008, but it does make it available once again for qualifying equipment bought and installed in 2009. Also, for 2009, the new law makes the credit available for certain types of energy efficient biomass fuel stoves and certain types of energy saving asphalt roofs.

Two-year extension of home mortgage debt forgiveness relief provision. The new law provides assistance to homeowners who have been caught in the current mortgage crisis and are trying to save their homes. Under 2007 tax legislation, taxpayers are generally allowed to exclude up to $2 million of mortgage debt forgiveness on their principal residence. However, this relief provision was scheduled to expire at the end of 2008. Under the new law, this debt relief provision is extended through 2012. To understand the importance of this relief provision, one needs to know that for income tax purposes, a discharge of indebtedness-that is, a forgiveness of debt-is generally treated as giving rise to income that's includible in gross income. Under pre-2007 tax law, there were no special rules applicable to discharges of acquisition debt on the taxpayer's principal residence. For example, assume a taxpayer who wasn't in bankruptcy and wasn't insolvent owned a principal residence subject to a $200,000 mortgage debt for which the taxpayer had personal liability. The creditor foreclosed and the home was sold for $180,000 in satisfaction of the debt. Under pre-2007 tax law, the debtor had $20,000 of debt discharge income. The result was the same if the creditor restructured the loan and reduced the principal amount to $180,000. In 2007 the tax laws were temporarily changed to allow taxpayers to exclude up to $2 million of mortgage debt forgiveness on their principal residence. For example, assume the same facts as in the foregoing example except that the discharge occurs in 2008. In that case the debtor has no debt discharge income when the creditor (1) restructures the loan and reduces the principal amount to $180,000 or (2) forecloses with the result that the $200,000 debt is satisfied for $180,000. However, this debt relief provision was scheduled to expire at the end of 2009. The new legislation extends the provision through 2012. The relief is not extended to home equity loans.

More detailed reporting of securities transactions - after 2010: Stock brokers must file an information return (Form 1099-B) for securities transactions they handle. Currently, brokers report the name and address of the customer, when the sale took place, what was sold, and the gross proceeds of the sale. Starting with stocks (as well as bonds and several other financial instruments) bought after 2010 (a later date applies to some specialized securities), brokers will have to report the customer's adjusted basis (essentially cost for tax purposes) and whether a gain or loss on the transaction was short- or long-term. This new information reporting requirement is designed to boost IRS's compliance efforts (e.g., help assure taxpayers properly report their gains and losses).

Research and development credit. The research tax credit is extended through 2009. In addition, the alternative simplified credit is increased from 12% to 14% for the 2009 tax year, and the alternative incremental research is repealed for the 2009 tax year.

15-year straight-line cost recovery for qualified leasehold, restaurant, and retail improvements. The 15-year writeoff for qualified leasehold, restaurant and retail improvements is extended through 2008.

Basis adjustment to stock of an S corporation making charitable contributions of property. Favorable Subchapter S basis rules for gifts of appreciated property are extended through 2009.

Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico. The provision allowing a Section 199 domestic production activities deduction for activities in Puerto Rico is extended through 2009.

Other provisions extended through 2009 include:

• Qualified zone academy bonds.
• Indian employment credit.
• Accelerated depreciation for business property on Indian reservation.
• Tax credit for certain expenditures for maintaining railroad tracks.
• 7-year recovery period for certain motorsports racetrack property.
• Work opportunity tax credit for Hurricane Katrina employees.
• New markets tax credit.
• Increased rehabilitation credit for structures in the Gulf Opportunity Zone.
• Enhanced charitable deduction for qualified computer contributions.
• Tax incentives for investments in the District of Columbia.
• Enhanced charitable deduction for food inventory.
• Enhanced charitable deduction for contributions of book inventory to schools.
• Special expensing rules for certain film and television productions.
• Exception under Subpart F for active financing income.

Charitable giving provisions extended for two years. Several popular charitable incentives expired at the end of 2007 and would not have been available to taxpayers on their 2008 tax returns if Congress had not acted. The new law restores the provisions and extends them for two years (through 2009).

The extended provisions include:

• IRA charitable rollover. This provision allows individuals aged 70 1/2 and older to donate up to $100,000 from their individual retirement accounts (IRAs) and Roth IRAs to public charities without having to count the distributions as taxable income. This giving incentive is particularly beneficial to those individuals who do not itemize their tax deductions and would not otherwise receive any tax benefit for their charitable contributions.
• Enhanced charitable deduction for food inventory. This provision allows businesses to claim an enhanced deduction for the contribution of food inventory. The new law also eliminates the percentage limitation for contributions made by certain farmers and ranchers after Dec. 31, 2007, but before Jan. 1, 2009.
• Enhanced charitable deduction for contributions of book inventory to schools. This provision allows C corporations an enhanced charitable deduction for donations of books to schools, public libraries and literacy programs.
• Enhanced charitable deduction for qualified computer contributions. This provision encourages businesses to contribute computer equipment and software to elementary, secondary, and post-secondary schools by allowing an enhanced deduction for such contributions.
• Basis adjustment to stock of S corporations making charitable contributions of property. Under this provision, if an S corporation makes a contribution to a charity the amount of a shareholder's basis reduction in the S corporation stock will be equal to the shareholder's pro rata share of the adjusted basis of the contributed property (rather than the pro rata share of the fair market value of the contribution, as was the case under prior law).
• New tax incentives for charitable giving. New incentives for charitable giving contained in the new legislation include:
• Temporary suspension of limitations on charitable contributions. The amount allowed as a charitable deduction in any year may not exceed ten percent of a corporation's taxable income or fifty percent of an individual's adjusted gross income. The new law temporarily waives these limits regarding charitable cash contributions dedicated to Midwestern disaster relief efforts. The provision is effective for contributions paid during the period beginning on the earliest applicable disaster date for all States and ending on December 31, 2008.
• Increase in standard mileage rate for charitable use of vehicles. The mileage rate individuals may use to compute a tax deduction for personal vehicle expenses associated with charitable work is statutory and has not been increased since 1997. It is currently set at 14 cents per mile. For a taxpayer assisting in relief efforts related to the Midwestern disaster, the new law sets the charitable mileage rate at seventy percent of the current standard business mileage rate, beginning on the applicable disaster date and ending on December 31, 2008.
• Exclusion from income of mileage reimbursements for charitable volunteers. In general, reimbursements received for operating expenses of a personal vehicle used in connection with charitable work in excess of the statutory charitable mileage rate are taxable income to the recipient. However, reimbursements for charitable mileage attributable to the Midwestern disaster up to the amount of the standard business mileage rate will not be considered taxable income through December 31, 2008.

Plug -In Electric Vehicle Provisions. The new law provides a tax incentive to purchase plug-in electric vehicles which, although they are still a couple of years away from reaching showrooms, are already poised for a tax break of up to $7,500 in the form of a new tax credit.

The tax credit for plug-in electric vehicles will range from $2,500 to $7,500 for light-duty vehicles, with factors such as battery capacity determining how much buyers will receive. The base-line credit will be $2,500 for vehicles powered by a 4-kilowatt hour battery. (By way of comparison, the current Toyota Prius stores 1.3 kilowatt hours.) An additional $417 will be added for each kilowatt hour of battery power beyond that, up to a total limit of $7,500 for light-duty vehicles (up to $15,000 for vehicles weighing more than 26,000 pounds). Thus, a light-duty vehicle with a 16-kilowatt hour battery pack (such as the prospective Chevrolet Volt) will get the maximum credit, which may help ease the burden of the expected steep sticker prices of plug-in electric vehicles. The new provision further encourages early buyers by stipulating that the credit will be phased out after the 250,000th plug-in electric vehicle has been sold.

Please keep in mind that we have described only the highlights of how the new law affects you. Our topical newsletters are for general information purposes and should not be considered as legal advice. If you would like more details, please call any of the members of the Taxation Practice Group at your convenience at 717-232-5000.