Tax Extenders for 2015 Arrive Early, Bearing Gifts
Author: Shawn Loader
Recent history led many taxpayers and tax professionals to anticipate an end-of-year rush to extend key expired business and individual tax provisions as seen in 2014 and prior. Allegedly as a precursor to establishing more robust tax reform in coming years, Congress is taking a different approach with the recently passed Protecting Americans from Tax Hikes (PATH) Act of 2015. This legislation, along with a $1.1 trillion omnibus spending package, has been signed into law.
The main downside to Congress’ thought and foresight into these provisions is the loss of the simplicity of extending all the provisions on the same basis or simply for an additional 12 months. Key provisions were extended either permanently or for multiple years, and many carry modifications with different effective dates than the extension applications. The act also contains numerous tax provisions unrelated to the extension of expired provisions. The changes aren’t without a hefty price tag; the approximate cost of the changes is $622 billion over the next 10 years.
Here are some frequently used and much-anticipated provisions, organized by their applicability to business or individual tax scenarios as well as the extension period applied.
Individual Permanent Extensions
Child Tax Credit (CTC) – Many families take advantage of this credit, which generally allows for a tax credit of up to $1,000 per child for joint filers with adjusted gross income (AGI) under $110,000 ($75,000 single). For taxpayers with insufficient income tax liability to use the full credit, an additional CTC is available that’s refundable based on a percentage of income over a threshold. This threshold was permanently reduced to a noninflation adjusted $3,000 from the $10,000 inflation indexed value that was set to resume for tax years starting in 2017. Many taxpayers won’t realize the difference since the permanent change is a continuance of provisions that have been in place since 2009, but the permanence should help eliminate a small uncertainty for planning purposes.
Enhanced American Opportunity Tax Credit (AOTC) – The AOTC is a tax credit for higher education expenses incurred during the first four years of post-secondary education. This credit is worth up to $2,500 per year for taxpayers filing joint returns with AGI of less than $160,000 ($80,000 single). The AOTC increased the overall credit amount and expanded the phase-out thresholds of the existing Hope Scholarship Credit for 2009 through 2017. The PATH Act makes these increased AOTC credit amounts and thresholds permanent. In addition, taxpayers filing claims of qualified expenses for the purpose of claiming the AOTC are required to report the Federal Employer Identification Number (EIN) of the institution to which these expenses were paid for tax years 2016 and later. Educational institutions are required to present their EIN information on the informational reporting forms provided to taxpayers beginning with tax years 2016 and later.
Earned Income Tax Credit (EITC) – Widely used by many low- and moderate-income taxpayers, the EITC has enjoyed temporary increases in credit amounts for taxpayers with three or more children as well as an elevated income phase-out level for taxpayers filing joint returns. These preferred provisions were set to expire in 2017 but have been made permanent with the recent legislation. The adjustment for the married filing jointly income phase-out threshold is now indexed to inflation as well.
Deduction for Certain Expenses of Elementary & Secondary School Teachers – An annual deduction allowed to elementary or secondary educators for classroom expenses is made permanent starting in 2015 and further expanded and improved for 2016 and beyond. The expansion will apply to tax years ending December 31, 2016, or later and now includes professional development courses related to the subject matter or students to whom the educator provides instruction. The deduction remains capped at $250 for 2015 but is indexed to inflation for 2016 tax years and later.
Parity for Exclusion from Income for Employer-Provided Mass Transit & Parking Benefits – Effective for tax years 2015 and forward, the allowable monthly exclusion as a de minimis fringe benefit permanently increases from $100 to $175. This move is intended to provide parity with a similar exclusion from wages and income taxation for qualified parking benefits provided by employers.
Deduction of State & Local General Sales Taxes – Since 2004, taxpayers electing to itemize deductions have enjoyed the option of deducting sales taxes in lieu of state and local income taxes. The deduction can be based on the actual sales tax amounts paid according to the taxpayer’s records or an IRS table calculation based on income plus additional taxes paid for purchases of automobiles, boats and other identified items. This primarily benefits taxpayers with few state income tax deductions and is made permanent starting with the 2015 tax year.
Changes Related to Charitable Giving – Two main provisions related to individual charitable giving are permanently codified through this legislation. The first is a permanent extension of individual taxpayers’ ability to exclude from gross income up to $100,000 of distributions made from individual retirement accounts to charitable organizations. The taxpayer must be at least 70½ years of age to use this provision, and it’s available for the 2015 tax year and beyond.
Another charitable provision in the legislation concerns the increased deductible percentage limits and increased carryforward period for contributions of real property for conservation purposes, which was permanently extended for tax years 2015 and later.
Individual Extension/Modification Items Extended Through 2016
Extension for Exclusion of Income from Discharge of Principal Residence Indebtedness – Hoping to be nearing the end of the need for this provision, the PATH Act extends the ability for taxpayers to exclude from gross income the discharge of indebtedness related to their qualified principal residence through the 2016 tax year. No definitions were altered that would change previous application of this provision, but it was specified that discharges that occur in 2017 as a result of written agreements finalized in 2016 will still qualify for exclusion under the provision.
Mortgage Insurance Premiums Treated as Qualified Residence Interest – For taxpayers with gross income under $110,000, this provision allows qualified mortgage insurance premiums to be treated in the same manner as mortgage interest, i.e., an itemized deduction.
Tuition & Fees Deduction – This deduction is a popular planning tool for getting more benefit out of higher education-related expenses. As highlighted in our 2015 Year-End Tax Advisor article, “Tax Planning for Education,” the tuition and fees deduction allows for a reduction of a taxpayer’s AGI of up to $4,000 for qualifying education expenses such as tuition expenses, fees, books, supplies and equipment expenses required as a condition of enrollment. Congress extended this provision through the 2016 tax year for joint filers with income of less than $160,000 ($80,000 for single filers).
Business Permanent Extensions
Extension & Modification of Research Credit – The PATH Act makes permanent and expands the application of the research and experimentation (R&E) credit, eliminating a perennial uncertainty. The permanent extension applies to tax years 2015 and later. Modifications to the R&E credit include the ability for eligible small taxpayers ($50 million or less in gross receipts) to apply the credit against alternative minimum tax (AMT) and for small startup businesses with limited taxable income to apply the credit earned against their payroll tax liability, up to $250,000. To qualify for the credit against payroll tax, a taxpayer must have less than $5 million of gross receipts in the current taxable year and not have any gross receipts for any year prior to five taxable years ending with the current year. These modifications are effective for tax years 2016 and later.
Extension of 15-Year Straight-Line Depreciation for Qualified Improvement Property – The PATH Act makes permanent the 15-year depreciable life for qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property and makes no modifications to the historic definitions of these assets. Recent guidance from the IRS regarding remodel/refresh expenses for restaurant and retail properties also may provide opportunities to accelerate deductions.
Extension of Section 179 Expensing Limitations & Treatments – In 2010 through 2014, very valuable preferential limitations were in place for Section 179 expensing of assets. Prior to the PATH Act, taxpayers faced a dramatically lower expensing limit and phase-out threshold. However, the provisions in this legislation restore the $500,000 expense limit and $2 million asset phase-out limit for the 2015 tax year. For tax years 2016 and later, these values are indexed for inflation. Rules regarding expensing of certain computer software and qualified real property also are permanently extended. In addition, air conditioning and heating units in service after the 2015 tax year will be eligible for Sec. 179 expensing. Lastly, the act modifies the expensing limit for qualified real property for tax years 2016 and later by eliminating the $250,000 cap.
Extension of Gain Exclusion of the Sale of Small Business Stock – Noncorporate taxpayers holding certain qualifying small business stock for more than five years will continue to enjoy a 100 percent exclusion of gain recognized on that stock, up to the greater of 10 times the basis in the stock or $10 million. The legislation also made permanent the rules eliminating excluded gains as an add-back for AMT purposes.
Extension of Reduction in S Corporation Built-In Gains Recognition Period – The PATH Act permanently reduces the period an S corp could be subject to an entity-level tax on built-in gain assets held during operation as a C corporation to five years from the previous 10 years. Special attention should be provided to distributions of prior C corp assets to S corp shareholders, as specific rules apply to that scenario. In addition, proceeds received on installment sales of prior C corp assets are subject to the rules in place when the installment sale began. This provision is effective for tax years 2015 and later.
Changes Related to Charitable Giving
The PATH Act makes permanent and enhances the provisions for charitable contributions of apparently wholesome food inventory for 2015 tax years and later. The act increases the allowable income limitation percentages for contributions by corporate taxpayers from 10 percent to 15 percent of income from the related activities. This rate change is in effect for the 2016 tax year and after.
Property contributions made through S corps also were addressed through this legislation, which permanently extends the rule that shareholders’ basis in their S corp stock is reduced by their pro rata share of the adjusted basis (versus fair market value) of property contributed by the corporation for charitable purposes.
Listed below are some additional permanent business provisions extended and/or modified by this legislation. Consult with your BKD advisor regarding specifics on these provisions:
- Extension and modification of employer wage credit for employees who are active duty service members, including elimination of the 50-employee cap for the 2016 tax year and after
- Extension of treatment of certain dividends of regulated investment companies (RIC)
- Extension of Subpart F exception for active financing income
- Extension of minimum low-income housing tax credit rates for nonfederally subsidized new buildings
- Extension of military housing allowance exclusion for determining whether a tenant in certain counties is low-income for purposes of the low-income housing credit
- Extension of RIC qualified investment entity treatment under the Foreign Investment in Real Estate Property Tax Act
Business Extensions Through 2019
Extension & Modification of Bonus Depreciation – Bonus depreciation is extended once again, but provisions for phaseout of the benefit were written into this legislation. Fifty percent bonus depreciation is allowable for tax years 2015 to 2017. Following that period, the bonus depreciation rate is reduced to 40 percent for 2018 and 30 percent for 2019. For tax years 2020 and later, bonus depreciation won’t apply, absent future legislation. Many of the previous rules regarding eligible assets and acceleration of AMT credits in lieu of bonus depreciation remain intact for the 2015 tax year. The 2016 tax year will see an acceleration of the amount of AMT credits able to be used in lieu of bonus depreciation. Tax years 2016 and later also bring enhanced eligibility for bonus depreciation to apply to certain trees, vines and plants bearing fruit or nuts where their eligibility date is determined by their date of planting or grafting rather than an in-service date.
Extension of New Markets Tax Credit
The act authorizes the allocation of $3.5 billion of new markets tax credits from 2015 through 2019. In addition, carryover periods continue to be allowed for five years, and the available window of credit carryovers is extended to 2024—five years following the provision’s end.
Extension & Modification of Work Opportunity Tax Credit (WOTC)
The WOTC is extended and enhanced by adding qualified long-term unemployment recipients to the list of eligible individuals. These individuals must be unemployed for a period not less than 27 consecutive weeks and have received federal or state unemployment benefits. Companies will be eligible to earn a higher credit amount of 40 percent applied to the first $6,000 of wages paid by the company to these qualifying long-term unemployed individuals. The WOTC is available through 2019. However, eligibility for qualified long-term unemployment recipients applies only to tax years starting after December 31, 2015.
Listed below are additional business provisions extended through 2016. Consult with your BKD advisor regarding specifics on these extended provisions:
- Indian employment tax credit
- Railroad track maintenance credit (including modification to qualifying expenditures)
- Mine rescue team training credit
- Qualified zone academy bonds
- Classification of certain race horses as three-year property
- Seven-year recovery period for motorsports entertainment complexes
- Accelerated depreciation for business property on an Indian reservation (including ability to elect out of acceleration rules in 2016)
- Election to expense mine safety equipment
- Special expensing rules for certain film, television and live theatrical productions
- Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico
- Empowerment zone tax incentives (including modification of enterprise zone facility bond employment requirement)
- Increase in limit on cover-over of rum excise taxes to Puerto Rico and the Virgin Islands
- American Samoa economic development credit
- Credit for nonbusiness energy property (including modification to efficiency standards requirement for windows, skylights and doors)
- Credit for alternative fuel vehicle refueling property
- Credit for two-wheeled plug-in electric vehicles
- Second-generation biofuel producer credit
- Biodiesel and renewable diesel incentives
- Production credit for Indian coal facilities (including modification to previous credit limitations)
- Credits with respect to facilities producing energy from certain renewable resources
- Credit for energy-efficient new homes
- Special allowance for second-generation biofuel plant property
- Energy-efficient commercial buildings deduction
- Special rule for sales or dispositions to implement FERC or state electric restructuring policy for qualified electric utilities
- Tax credits relating to alternative fuels (including propane)
- Credit for new qualified fuel cell motor vehicles
Other Miscellaneous Provisions
Moratorium on Medical Device Excise Tax & Other ACA Delays – A two-year moratorium on the 2.3 percent excise tax on medical devices is in effect for sales during the period beginning January 1, 2016, and ending December 31, 2017. The tax targets medical devices not typically purchased by individual consumers in a retail setting and remains unchanged for device sales from the tax’s enactment through December 31, 2015. The accompanying spending package also includes a delay of the Affordable Care Act’s “Cadillac” tax on high-dollar health insurance plans until 2020 as well as a one-year delay until 2018 of the health insurance provider fee.
REIT Provisions – Several sections of the PATH Act address various elements of real estate investment trust (REIT) taxation and transactions, including:
- Clarity is provided for a successful tax-free REIT spinoff, specifying that both the distributing and controlled corporations are required to be REITs immediately after the distribution in order for the transactions to qualify as tax-free
- Distributing and controlled corporations are prohibited from electing to be treated as REITs for 10 years following a tax-free spinoff transaction
- The provision is effective for distributions after December 7, 2015, except for transactions currently subject to or submitted to the IRS for a ruling request on or before the effective date
- Specifies that a REIT subsidiary taxed as a corporation may not represent more than 20 percent of the value of the REIT’s assets for tax years beginning after 2017
- Provides an alternative three-year averaging safe harbor for determining the percentage of assets a REIT may sell, applied independent of whether the asset is considered inventory property
- Repeals the preferential dividend rule for publicly offered REITs for tax years after 2014
- Authorizes the IRS to use appropriate alternative remedies for a preferential dividend distribution in lieu of treating the dividend as not qualifying for the REIT dividend deduction if the preferential distribution is inadvertent or due to reasonable cause rather than willful neglect
- Limits the designation of dividends by REITs as qualified or capital gain at no more than the dividends actually paid by the REIT for tax years beginning after 2014
- Provides additional inclusions to real property assets for meeting the 75 percent assets test including debt instruments issued by publicly offered REITs, interests in mortgages or in real property and ancillary personal property that is leased with real property
- Modifies REIT earnings and profits calculation to avoid duplicate taxation
- Clarifies that a taxable REIT subsidiary is permitted to provide certain services to the REIT that are normally performed by a third party; these include marketing and developing REIT real property and should not subject the REIT to the 100 percent prohibited transactions tax
Modification of Filing Dates for Informational Forms – An earlier filing date of January 31 is mandated for Forms W-2, W-3 and any nonemployee compensation reporting forms, i.e., Form 1099-MISC, and are no longer eligible for the extended filing date of March 31. This change takes effect for calendar years beginning after the enactment of the legislation, meaning taxpayers will first feel the impact of this provision for 2016 calendar year-end. In addition, overpayment refund requests filed after December 31, 2016, won’t be fulfilled before the 15th day of the second month following the close of the taxable year at issue if the taxpayer claimed the earned income tax credit or the additional child tax credit. These provisions were included to address ongoing fraudulent activities regarding refund requests.
Safe Harbor for De Minimis Errors on Informational Form Reporting – The act establishes safe harbors for errors in informational reporting to alleviate the need for corrected returns for individual misstatements of $100 or less for items of income or $25 or less for items of tax withholding. These changes are effective for statements required to be filed after December 31, 2016.
529 Account Rule Changes – Permanency was provided to an expanded definition of eligible education expenses for 529 plan withdrawals. These expenses include computers and peripherals, software and Internet access and related services if such equipment and services are to be used primarily by the beneficiaries during the years they are enrolled at an eligible educational institution. Also, relief is provided for recipients of tuition refunds of amounts paid with 529 plan distributions, allowing a taxpayer to recontribute the refunded amounts to the plan within 60 days of receipt. This provision is retroactive for any refunds received after December 31, 2014, as long as amounts are recontributed within either 60 days of the enactment of the law or 60 days of the receipt of the refund.
Changes for Small Insurance Companies – Modifications were made for small insurance companies wholly owned and controlled by their insured (commonly referred to as captive insurance companies) regarding the maximum amount of annual premiums these companies can receive and still elect to be exempt from tax on their underwriting income. The limit increased from $1.2 million to $2.2 million for tax years after 2016 and carries inflation-indexed adjustments for all subsequent periods. To help prevent abuse, the act added a diversification requirement for small insurance companies to be eligible for the premium income exclusion election. Under these rules, one of the following requirements must be met:
- Risk Diversification Test – No one policy holder may make up more than 20 percent of the greater of net written premiums or direct written premiums of the insurer.
- Relatedness Test – Owners of the insured must own an equal or greater share of the business or assets as they own in the insurer. This ownership test only applies to a spouse and lineal descendants (including by adoption), and a 2 percent de minimis exception applies. This test was included to address perceived abuses of captive insurance companies for estate planning purposes.
Any insurance company that made an election to exclude premium income will be required to report certain information as required by the IRS relating to the diversification requirements for tax years beginning after December 31, 2016.
This article isn’t inclusive of all the changes in the more than 200 pages of legislation. The provisions generally were favorable to taxpayers and aimed at simplifying the complicated task of applying the tax code to business and financial decisions. Finance Committee member Ron Wyden, one of the congressmen responsible for drafting the legislation, promised additional changes in the near future, saying this law was simply “a down payment on tax reform.”
If you have questions regarding this legislation or any of the many changes in 2015, please contact your BKD advisor.
Note: BKD will host a complimentary, one-hour webinar on Tuesday, January 12, 2016, covering the various provisions included in the PATH Act. Click here to register.