New tax laws provide mortgage & AMT relief
After a fairly lackluster year on Capitol Hill, Congress rushed to pass several highly anticipated tax bills before recessing for the holiday break. Here’s a look at the key laws and how they may affect you:
Mortgage relief
Congress spent much of 2007 trying to hammer out legislation that would offer help to homeowners caught in the subprime mortgage crisis. The Mortgage Forgiveness Debt Relief Act of 2007, signed into law by President Bush on Dec. 20, 2007, creates a three-year exception (from Jan. 1, 2007, through Dec. 31, 2009) to current law so that affected homeowners won’t have to pay federal income taxes for debt forgiveness on their troubled loans. This provides relief to homeowners who receive debt forgiveness in a foreclosure or in a mortgage workout, under which the terms of the mortgage are changed, resulting in a lower mortgage balance.
The law specifically applies to mortgages on a principal residence, and not to vacation or secondary homes. The law also doesn’t apply to taxpayers in Chapter 11 bankruptcy.
Moreover, the new law extends through Dec. 31, 2010, a provision enacted in 2006 that allows taxpayers to take an itemized deduction for premiums paid or accrued on qualified mortgage insurance. The law applies only to contracts entered into after Dec. 31, 2006, and before Jan. 1, 2011.
Another provision of the mortgage act extends the time period that a recently widowed person can use the joint-return filers’ $500,000 home sale gain exclusion to cover sales occurring up to two years after the spouse’s death. Plus, the act clarifies the low-income housing credit and the definition of a cooperative housing corporation.
AMT Patch
The alternative minimum tax (AMT) continues to be a bugaboo for Congress. They understand the need to overhaul the system, but can’t seem to find the key to simplifying it. With time running out, Congress finally approved a “patch” that includes 2007 AMT exemption amounts that are significantly higher than they would have been without the act but only slightly higher than the 2006 amounts. Under the Tax Increase Prevention Act of 2007, signed into law by President Bush on Dec. 26, 2007, the 2007 amounts are: $44,350 for singles and heads of households, $66,250 for married filling jointly, and $33,125 for married filling separately.
The IRS and Treasury Department estimated that, without the patch, roughly 25 million taxpayers would have paid on average $2,000 more in taxes for 2007. Once again, this issue will need to be addressed for 2008 because the increased exemption is only for 2007.
The new law provides additional AMT relief by allowing more nonrefundable personal credits, such as the dependent care, Hope and Lifetime Learning credits, to be used to reduce AMT liability. (Many other popular credits, such as the child and adoption credits, were already eligible.)
As a result of the changes, the IRS is asking taxpayers filing certain forms to wait to file until Feb. 11, 2008. Affected forms include Form 8863, Education Credits; Form 5695, Residential Energy Credits; and Form 8396, Mortgage Interest Credit. Several other AMT-related forms, however, aren’t affected.
It’s also important to note that the 2007 tax materials that you’ll likely receive from the IRS in early January were printed before the new tax laws were passed.
Energy Issues
On Dec. 19, 2007, the president signed into law a new energy bill. The Energy Independence and Security Act of 2007 raises fuel economy standards for automobiles and sets standards for improving the efficiency of home appliances. Provisions that were NOT included in the bill, but which may be resurrected in 2008, include extensions of the residential energy efficiency credits and research credit. In addition, future legislation may extend and enhance the alternative motor vehicle credit.
Other items of note
Technical corrections were also made to nine major tax laws dating back to 1998. Perhaps the most notable is a clarification of the definition of the AMT refundable credit. The change allows taxpayers to better take advantage of long-term unused credits.
Moreover, under a special tax law signed by President Bush on Dec. 19, victims and family members affected by the April 2007 Virginia Tech massacre may exclude from their gross income any payments they receive from a special memorial fund set up on their behalf after the tragedy.
Important change in IRS Section 409A compliance deadline for nonqualified deferred compensation plans
On Sept. 10, 2007, the Treasury Department and the IRS announced, in IRS Notice 2007-78, that companies will have until Dec. 31, 2008, to bring documents into compliance with the final nonqualified deferred compensation regulations under Section 409A of the Internal Revenue Code. Previously, the deadline was Dec. 31, 2007.
Sec. 409A applies to a broad variety of deferred compensation arrangements and sets forth requirements that affected plans must satisfy. Any company with a nonqualified deferred compensation plan — a deferred compensation plan that is generally designed to favor only certain individuals or groups of individuals — should be certain that the plan is in compliance with the law. The penalties for noncompliance can be severe: Plan participants will be taxed on plan benefits at the time of vesting, and a 20% penalty tax and potential interest charges also will apply.
It’s important to note that the notice extends only the time for bringing plan documents into conformity with Sec. 409A. It does not extend the effective date of the final regulations, which remains Jan. 1, 2008.
This means that, although plan sponsors now have until Dec. 31, 2008, to conform their plan documents to Sec. 409A, they must operate and administer their plans in compliance with the final Sec. 409A regulations by Jan. 1, 2008. (They must also have operated their plans in “good faith” compliance with Sec. 409A retroactive to 2005, when the requirements first went into effect.)
Plan sponsors should identify all plans or arrangements that may be subject to Sec. 409A and have them reviewed to ensure that they’re operationally and administratively Sec. 409A compliant. If they have plans that aren’t compliant, they should bring the plans — and plan documents — into conformity with Sec. 409A as soon as possible but no later than the applicable deadlines.
The Treasury Department and the IRS expect to issue further guidance regarding a limited voluntary compliance program that will help companies correct specific unintentional operational violations of Sec. 409A. But no date has been set for issuing that guidance.
Please consult us to find out exactly how this IRS notice affects your nonqualified deferred compensation plan.
On May 25, the President signed the Small Business and Work Opportunity Tax Act of 2007 (SBWOTA). Passed in conjunction with legislation to continue funding the war in Iraq and to raise the minimum hourly wage, the tax-related provisions are designed in part to provide benefits to small businesses likely to be hit hard by the minimum wage increase.
Following are highlights of key provisions affecting businesses and individuals, as well as GO Zone incentives and other areas of tax law.
Businesses
The Section 179 election to expense property in its initial year (rather than depreciate it) is extended through 2010 and increased from $100,000 to $125,000, effective for years beginning after 2006. The expense deduction begins to phase out if more than $500,000 of eligible property is placed in service during the year (up from $400,000). These amounts will be adjusted for inflation annually.
The Work Opportunity tax credit, which had been set to expire Dec. 31, 2007, is extended until September 30, 2011. This credit is available to businesses that hire employees from targeted groups of individuals, such as veterans, ex-felons, high-risk youth, and food stamp and supplemental security income recipients. The new law expands this list to include disabled veterans and individuals in counties that have suffered significant population losses. If you hire a target employee, your business can receive a 40% tax credit for the first $6,000 paid to that worker.
The individual and corporate alternative minimum tax (AMT) limits on the use of certain credits are waived, effective for years after 2006 as well as for carry-back of these credits. This applies to the Work Opportunity credit and the credit for taxes paid on employee tips. Employers are also now eligible for the full tip credit despite the increase in the minimum wage.
SBWOTA includes certain S corporation and pension provisions, but they are generally too obscure and technical to cover in this Alert. Contact your tax advisor to ascertain whether any of these changes affect your tax planning strategies.
Individuals
The new law also affects some individual taxpayers. The “kiddie tax,” which subjects children (and now young adults) to tax on most unearned income at their parents’ marginal tax bracket, had recently been expanded to include those under age 18 (up from age 14). Now, SBWOTA broadens that rule to include those who qualify as dependents because they are either under age 19, or under age 24 and a full-time student, if their earned income doesn’t exceed one half of the amount needed for their support.
GO Zone incentives
In addition, SBWOTA extends several tax incentives designated for the Gulf Opportunity Zone (GO Zone):
The increased Sec. 179 expense election, which is generally doubled for qualifying property, is extended through 2008.
The low-income housing tax credit for GO Zone housing is extended through 2010.
Tax-exempt bond financing for GO Zone property is expanded to include expenses for all repairs and reconstruction. The provision applies to owner financing provided after May 25, 2007, and before 2011.
Other changes
Finally, the act subjects tax return preparers to increased levels of penalty for the redefined category of “unreasonable positions” taken on a tax return, as well as for the category of “willful and reckless” tax positions. The legislation also makes changes in the pension area, as well as numerous other minor changes and technical corrections.
Tax Relief and Health Care Act of 2006
On Dec. 20, 2006, President Bush signed into law the Tax Relief and Health Care Act of 2006. In addition to extending certain tax provisions that had expired at the end of 2005 or that had been set to expire soon, the act introduces some new rules and important tax breaks we think you’ll want to know about.
Extensions benefiting individuals
Some of the extended provisions are specific to individuals. Two of the more significant — both extended through 2007 — are:
1. The state and local sales tax itemized deduction. This deduction, which had expired at the end of 2005, allows you to deduct either state and local income taxes or state and local sales taxes. It primarily benefits those living in states with no income tax but may also benefit taxpayers who live in low-income-tax states or who purchase major items, such as cars or boats. Referring to the Optional State Sales Tax Tables in IRS Publication 600 is the easiest way to calculate the deduction. But if you spend more than average for your income level, you may enjoy a larger deduction by saving your receipts and totaling up the actual sales tax paid.
2. The above-the-line deduction for college tuition payments. This deduction also had expired after 2005. It allows you to deduct “above the line” a portion of qualified higher education tuition and fees. Taxpayers with adjusted gross incomes (AGIs) not exceeding $65,000 for singles and $130,000 for joint filers are eligible for a maximum annual deduction of $4,000. Those with AGIs up to $80,000 for singles and $160,000 for joint filers can deduct up to $2,000.
Note that you can’t claim this deduction if you claim the Hope or Lifetime Learning credit for the same student. But the AGI phase out ranges for the credits are lower ($45,000 – $55,000 for singles and $90,000 – $110,000 for joint filers). So the deduction may benefit you if you don’t qualify for the credits.
Other extensions that benefit individuals include the deduction for up to $250 of qualified out-of-pocket teacher expenses (through 2007), the availability of Archer Medical Savings Accounts (through 2007), and the credit for certain residential alternative energy expenditures (through 2008).
Extensions benefiting businesses
Several provisions geared more toward businesses have also been extended, including:The research and development (R&D) credit. This credit, which had expired at the end of 2005, has been extended through 2007. Generally, it is equal to 20% of qualified research expenses in excess of a certain amount based on the company’s historical activity. But businesses can instead take the alternative incremental credit (AIC), based on a stated percentage of qualified expenses in excess of average expenses over four years.
For 2007 the new law enhances the R&D credit in two ways. First, it increases the stated percentage for the AIC. Second, it offers the alternative simplified credit (ASC), equal to 12% of qualified research expenses exceeding 50% of the previous three tax years’ average expenses. If there were no qualified expenses in any of those years, the ASC equals 6% of the current year’s expenses.
Combined with previous rule changes that have liberalized the requirements for taking this credit in recent years, the new law makes the credit a powerful tax-saving tool for many businesses.
Employment credits for hiring low-income workers. The new law not only extends the previously expired Welfare-to-Work and Work Opportunity credits through 2006 but also combines and enhances them for 2007. These credits benefit businesses hiring employees from certain economically disadvantaged groups, such as ex-felons and food stamp recipients. The credits generally equal 40% of qualified first-year wages or 25% of such wages if employment is more than 120 hours but less than 400. “Qualified” wages cannot exceed $6,000. This means that, depending on whether the 40% or 25% amount applies, the credit cannot exceed either $2,400 or $1,500 per eligible employee. Combining the two credits should make calculations easier.
The other 2007 enhancements include an extension of the time employers have to file certification documents and elimination of the requirement that ex-felons be from an economically disadvantaged family.
Accelerated depreciation for leasehold and restaurant improvements. The extension of this provision through 2007 allows a shortened recovery period of 15 years (rather than 39 years) for qualified leasehold and qualified restaurant improvements. Those made to the interior of a nonresidential building more than three years after the building was placed in service generally qualify. And the improvements can be made by either the lessor or the lessee.
Energy-related tax breaks. Many provisions have been extended through 2008, including:The credit for energy efficient new homes,The deduction for energy efficient commercial buildings,The renewable electrical energy production credit, andThe authority to issue clean renewable energy bonds.
Other extensions that benefit businesses include Gulf Opportunity Zone bonus depreciation (through 2010), the ability to deduct rather than capitalize certain environmental remediation costs (through 2007), and the deduction for corporate donations of certain computer and scientific equipment to schools and public libraries (through 2007).
HSA enhancements
As the act’s name suggests, it also addresses health care, specifically Health Savings Accounts (HSAs). The new law makes notable and permanent changes to the HSA rules. HSAs allow you to contribute pretax income to an account that bears interest or is invested in mutual funds, and withdrawals for health care expenses are tax free. The maximum HSA contribution previously was limited to the lesser of the policy’s deductible or the IRS-sanctioned maximum allowable amount. Now, starting in 2007, the policy’s deductible does not factor into the contribution limit.
Thus, regardless of the policy’s deductible, for 2007 the contribution limit is $2,850 for a policy with individual-only coverage and $5,650 for a policy that covers the participant’s family.
Other important changes with respect to HSAs include the following:
Annual contribution limits are no longer pro-rated for participants who become eligible during the year, so long as they are eligible at the end of the year. One caveat is that participants who later become ineligible may be subject to a recapture of prior deductions.
Participants can make a one-time transfer to their HSAs from flexible spending accounts (FSAs) and health reimbursement accounts (HRAs). The maximum transfer is the account balance on the day of the transfer or on Sept. 21, 2006, whichever is less. Transfers can be made on or after the date of enactment through Dec. 31, 2011.
And, in an effort to allow quicker access to retirement savings to pay medical expenses, the new law allows participants to make a one-time, irrevocable rollover of funds from an IRA into an HSA after Dec. 31, 2006. The rollover, which is neither taxable as an IRA distribution nor deductible as an HSA contribution, is limited to the maximum allowable HSA contribution for the year.
Expanded AMT credit
In an effort to help taxpayers who were stung by the AMT when they exercised qualified stock options and who haven’t been able to use the resulting AMT credit in subsequent years, the new law allows for a refundable credit starting in 2007 and ending in 2012. The refundable amount each year depends on your long-term unused minimum tax credits and AGI. You may be able to claim as much as 20% of the unused AMT credit each year as a refundable credit if the unused amount is significant. Otherwise, you may be eligible to use the lesser of $5,000 or the entire unused amount.
More tax breaks, technical corrections and obsolete tax forms
Also included in the law is a new provision that permits you to deduct amounts paid for private mortgage insurance premiums — but only for amounts paid during 2007 and only in certain situations. Further, there are various miscellaneous provisions in the law that range from breaks with narrow applicability, such as permanent capital gains treatment for self-created musical works, to items as innocuous as technical corrections.
One interesting impact of changes being passed so late in the year is that the 2006 tax forms have already been printed and will have to be updated.
The bottom line
There are many tax saving opportunities within the Tax Relief and Health Care Act of 2006 — some that may greatly benefit you. Please call us for more information about this important tax law and to see how you might take full advantage of it to reduce your tax liability for 2006, 2007 and beyond.