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2008 Tax Law Updates
December 12, 2008
Congress Passes Emergency Pension Tax Relief/Technical Corrections
The continuing drumbeat of bad economic news has spurred the lame-duck Congress to pass an
emergency package of pension recovery provisions and pension-related technical corrections. The
Worker, Retiree, and Employer Recovery Act of 2008 ( H.R. 7327), approved by Congress on December
11, suspends required minimum distributions (RMDs) from 401(k) plans, IRAs and similar retirement
accounts for 2009, provides pension plan funding relief, and includes long-awaited technical
corrections to the Pension Protection Act of 2006 (PPA) (P.L. 109-280). President Bush is expected to
sign the Worker, Retiree, and Employer Recovery Act as soon as it reaches his desk.
This year-end round of tax legislation foreshadows much more tax legislation, first in the form of a
large stimulus bill, expected to be unveiled by the 111th Congress before President-elect Barack Obama
takes office. Pension benefits experts also forecast that the Worker, Retiree, and Employer Recovery Act
represents only the first step in shoring up retirement plans, with further relief likely in 2009.
Impact. The pension package was pushed through Congress before year-end largely in response to two
immediate concerns: (1) the inability of many pension plans to meet new funding obligations that would
lead to frozen plans and business cutbacks and (2) the hardship placed on many retirees if they were
forced to take RMDs when their retirement savings are at their lowest point in years.
Impact. Two powerful business tax breaks were removed from the final version of the new law:
extensions of 50-percent business depreciation and increased Code Sec. 179 expensing. Although both
incentives are on track to terminate at the end of 2008, chances remain very good that these tax
incentives will be extended into 2009, retroactively in the stimulus bill set for passage in January under
the new Obama Administration.
REQUIRED MINIMUM DISTRIBUTIONS
Many retirees, especially those who have recently retired, have been rocked by the nose-dive in value of
their retirement savings accounts since September. Existing tax rules would have forced them to
further deplete their tax-deferred nest eggs when they are at their lowest by taking RMDs from their
qualified plans or IRAs.
The new law suspends RMDs from qualified retirement accounts for 2009. RMDs for 2008 are not
waived by the new law.
Impact. A Treasury Department spokesperson told CCH that the Treasury is aware of the problems
surrounding RMDs for 2008 and depleted retirement assets. The Treasury is "looking at this issue but we
have no timeframe for any decisions or announcements," the spokesperson said. The Treasury could
issue administrative relief, ameliorating the impact of RMDs for 2008.
Ordinarily, by April 1 of the calendar year following the year in which an individual reaches age 701/2, the
remaining balance in any tax-deferred retirement savings account (401(k) plan, 403(b) plan, IRA,
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etc.) must be distributed to the individual in full or the individual must begin to receive RMDs from the
account. For years subsequent to the first year of retirement, RMDs ordinarily must be made by the end
of the current year. In either case, RMDs are calculated based on the account's balance as of the last
business day of the year prior to the year for which the RMD must be made. The IRS imposes an excise
tax of 50 percent to the extent a RMD in the proper amount is not made. Under the new law, that excise
tax is waived on all 2009 RMDs underpayments ordinarily distributed to retirees.
Example. Laura Jones, a retiree in the 28-percent tax bracket, is required to withdraw $10,000 from
her IRA as a RMD. Laura does not make the RMD. The IRS under the permanent rules would impose a
50-percent excise tax ($5,000). Additionally, Laura would have been liable for $2,800 in income tax,
leaving her with $2,200 to show for the $10,000 distribution.
Caution. The new law does not relax the rules that discourage early distributions from IRAs and other
arrangements. Some lawmakers, and Obama on the campaign trail, proposed allowing distributions of 15
percent, up to $10,000, from retirement accounts without penalty for 2008 and 2009 to help taxpayers
cope with tough economic times. Those over age 591/2, however, may withdraw funds from a retirement
account penalty free under existing rules; they must, however, pay income tax on those withdrawals.
Comment. The IRS issued final regulations on the determination of RMDs in 2002. The life expectancy
table in the 2002 final regulations substantially lengthened the period over which RMDs are to be made
when compared to both 1987 and 2001 proposed regulations.
For all retirees, RMDs are just that: minimum distributions that are required. Distributions up to the full
balance of the account continue to be allowed at any time without penalty, but with the usual recognition
of ordinary income on the taxable amount withdrawn.
Caution. The new law also allows the beneficiaries not to receive distributions in 2009 for the
purpose of implementing the five-year RMD schedule imposed on distributions received by beneficiaries
after the death of an account holder.
Comment. Distributions from an IRA that are transferred directly to a charity are excluded from the
recipient's income, but count against the recipient's required minimum distribution for the year. The
suspension of the required minimum distribution requirement may lead to a decrease in charitable
distributions in 2009.
NON-SPOUSE ROLLOVERS
Before the PPA, the ability to roll over a decedent's interest in a qualified plan, 403(b) plan or 457 plan
was limited to surviving spouses. The PPA extended this treatment to non-spouse beneficiaries effective
for distributions after December 31, 2006. The rollover must be accomplished via a trustee-to-trustee
transfer and the minimum distribution rules of Code Sec. 401(a)(9) must be followed (rather than special
rules applicable only to surviving spouses). The new law clarifies that all plans must permit rollovers out of
the plan for non-spouse beneficiaries and provide notice of the distribution.
Impact. In Notice 2007-7, the IRS indicated that non-spouse rollovers were not mandatory. Many
lawmakers objected to the IRS's interpretation and the new law clarifies that plans are required to permit
non-spouse rollovers.
Impact. Effective for plan years beginning after December 31, 2009, qualified plans must permit non-
spouse rollovers. Until then, the new law clarifies that they are allowed.
Caution. The new law appears to confirm that, as under existing law, there is no non-spouse rollover
available from IRAs.
Comment. The new law also clarifies that rollover distributions do not reduce unemployment
compensation. Additionally, the new law clarifies that a qualified rollover contribution to a Roth IRA from a
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Roth 401(k) or 403(b) is not subject to the adjusted gross income limit or other requirements applicable to
rollovers from non-Roth eligible plans.
PUBLIC SAFETY OFFICERS
The new law extends the current $3,000 exclusion for health insurance premiums for retired public safety
officers to self-funded arrangements. To be excluded, however, the amounts used to pay the premiums
must be distributed from a public safety officer's former employer's retirement plan.
PENSION PLANS
The PPA was enacted to strengthen defined benefit (DB) pension plans rather than accelerate the trend
for businesses to eliminate them in favor of defined contribution (DC) plans or providing no retirement
plans at all. Although increased funding requirements under PPA may have remained compatible with
that goal under normal economic circumstances, many businesses suddenly cannot meet their new
funding obligations without jeopardizing both their defined benefit plans and the survival of the business
itself, along with the jobs that it provides. Plan administrators are coming face-to-face with a December
31st funding deadline that could not wait to be addressed in 2009 legislation.
Single Employer Plans
Eased funding rules. The PPA set transitional funding targets for pension plans but many employers are
unable to meet even these reduced amounts because of the economic downturn. Under the new law,
plans that fall below the target funding percentage for a particular year (92 percent for 2008 and 94
percent for 2009) will be required to make subsequent contributions up to the specified funding
percentage for that year instead of the 100-percent amount required under the previous "cliff" provision
set under the PPA.
Impact. Businesses argued that, although the eventual 100-percent funding target under PPA is both
reasonable and desirable, that target was now being phased in under economic circumstances
unforeseen by Congress when the PPA was enacted. Many businesses can now temporarily allocate
more of their financial resources to current business operating needs.
Two-year smoothing. Prior to the PPA, businesses were able to recognize unexpected pension plan
asset gains and losses over four years. Although the PPA reduced that smoothing period to two years, its
application was open to interpretation. Proposed Treasury regulations would require use of the fair market
value of assets to determine the level of current required funding rather than use of a smoothed value that
recognizes unexpected gains and losses over two years. Especially in a slowing economy, smoothing can
help lower the immediate cost of meeting certain funding levels. The new law clarifies the use of
smoothing to allow the recognition of unexpected asset gains and losses over a 24-month period.
Benefit accruals. To avoid restrictions on benefit accruals as a result of being less than 60-percent
funded, the new law allows plans to look back to the previous plan year to determine their funding status
adjusted funding target attainment percentage (AFTAP), rather than use the current year's AFTAP. This
provision would apply for plan years beginning on or after October 1, 2008, and before October 1,
2009. For plan years beginning January 1, 2009, that means a look back to January 1, 2008,
conditions.
Impact. Application of the benefit limitations will be based on the earlier year, before the market collapse
of 2008.
If the plan's funding level falls below 60 percent, Code Sec. 436 generally forbids any distributions of
accelerated benefits. The new law permits lump-sum payments of $5,000 or less without participant
consent, as allowed by Code Sec. 411(a)(11), even if the plan is otherwise prohibited from paying lump
sums.
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Comment. The new law also helps payouts from small defined benefit plans by determining the value of
lump-sum distributions not in excess of the Code Sec. 415 limit using a fixed 5.5-percent interest rate,
rather than pegging the limit at the old "greater of 5.5-percent or 105-percent of the corporate bond yield
curve rate."
Multi-Employer Plans
The PPA provides additional funding rules for multi-employer plans that are in "endangered or critical
status." The new law relaxes some of these funding restrictions to help multi-employer plans during the
economic downturn.
For plan years beginning on or after October 1, 2008, and before October 1, 2009, the new law allows
multi-employer plans to elect to freeze their current funding certification based on the previous plan year's
status. If the plan was in endangered or critical status for the preceding plan year, the plan also was not
required to update its funding improvement plan or schedules until the following plan year.
The new law provides a three-year extension, from 10 to 13 years, of the current funding improvement
and rehabilitation period for multi-employer plans in critical or endangered status for 2008 or 2009. If
the plan is in seriously endangered status, its funding improvement period is extended to 18 years rather
than 15 years.
Comment. If a multi-employer plan is certified by the plan actuary to be in endangered or critical status,
notification of the endangered or critical status must be provided within 30 days after the date of
certification to participants and beneficiaries. The new law does not relax this or other heightened and
accelerated funding notification requirements under the PPA.
At-Risk Plans
Under the PPA, plans with more than 500 participants that have a funded target attainment percentage
(FTAP) in the preceding year below designated thresholds would be deemed at-risk and are subject to
increased target liability for plan years beginning after 2007. The new law applies the 2008 transition rule
for determining at-risk status to both the 70-percent and 80-percent prongs of the two-tiered
determination of at-risk status.
Comment. A plan is at-risk if the FTAP for the preceding year is less than 80-percent and the FTAP for
the preceding plan year, determined by applying the specified at-risk actuarial assumptions, is less than
70-percent. Both components of the test must apply for a plan to be treated as at-risk.
Small Plans
The benefit restriction rules are based upon a plan's AFTAP as of the first day of the plan year. However,
a small plan (100 or fewer participants) is allowed to designate any day of the plan year as its valuation
date for that plan year and succeeding plan years. The new law authorizes the Treasury and the IRS to
establish special rules regarding small defined benefit plans that have an alternate valuation date for
purposes of quarterly contributions and application of the benefit restrictions.
Hybrid Plans
A hybrid plan is a defined benefit plan that combines elements of traditional defined benefit (DB) plans
with elements of defined contribution (DC) plans. A cash balance plan is a type of hybrid plan that pays
benefits based on a separate hypothetical account. Code Secs. 411(a)(13) and 411(b)(5), added by the
PPA, allow the operation of cash balance plans and provide protection for older participants. The new law
provides some relief for hybrid plans.
The new vesting rules for hybrid plans would be effective on the basis of plan years and apply to
participants with an hour of service after the applicable effective date for the plan.
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The new law provides that the new PPA interest crediting rules for hybrid plans in existence on
June 29, 2005, apply to years beginning after December 31, 2007, unless the sponsor elects to
apply the rules earlier.
The new law provides that the special PPA effective date for the vesting and interest crediting
requirements for applicable plans that are collectively bargained does not apply to plan years
beginning before the earlier of: (1) the later of January 1, 2008, or the termination of the collective
bargaining agreement; or (2) January 1, 2010.
Automatic Enrollment
The PPA encouraged employers to adopt automatic enrollment in DB plans. The new law clarifies the
permissible withdrawal rules within automatic enrollment arrangements and extends them to cover simple
retirement accounts (SIMPLE IRAs under Code Sec. 408(p)) and simplified employee pensions
(SARSEPs).
Impact. During the campaign, Obama proposed expanding retirement savings options for lower and
middle income individuals, particularly emphasizing automatic enrollment and possibly making it
mandatory rather than optional.
Governmental Plans
Governmental retirement plans that credit a plan participant's account balance with a specified interest
rate will be permitted to use a rate that exceeded the "market rate of return" (as defined by the Treasury),
provided the governmental plans' interest rate was set by federal, state, or local law.
Combined Plan Deduction Limit
The new law modifies the overall deduction limit for employers that maintain one or more DC plans and
one or more DB plans. Under the new law, if contributions to DC plans are less than six percent of
compensation, the DB plan is not subject to the overall deduction limit. If contributions to DC plans
exceed six percent of compensation, only defined contributions in excess of six percent are counted
toward the overall deduction limit. Prior to the new law, the overall deduction limit applied to the total
contributions to all plans for a plan year.
State/Local Health Insurance Reimbursements
The new law adds a new provision to Code Sec. 105, which determines tax treatment of amounts
received under accident and health plans. The new provision clarifies that amounts received back under
qualifying state and local government sponsored health plans will continue to be excluded from the
taxpayer's gross income, even though the plan may reimburse the health care expenses of the deceased
taxpayer's beneficiary.
Plan Expenses
The new law requires plan expenses expected to be paid out of plan assets to be included in calculating
the plan's target normal cost.
PENALTIES
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Many Capitol Hill observers see "pay-go" rules, which require an equal amount of revenue raisers as
tax breaks in a bill, as a thing of the past until the current economic crisis ends. As a result, the new law
is not revenue neutral, although several tax breaks were in fact scored as revenue raisers under the
assumption that plans would otherwise terminate without them. Two clear revenue raisers, however, were
included that impact directly on S corporations and partnerships.
S Corp Penalties
The law increases the monthly multiplier from $85 to $89 for the Code Sec. 6699(b)(1) failure-to-file
penalty applicable to S corporation income tax returns. This provision applies to returns filed after
December 31, 2008, and it is expected to raise an additional $38 million in revenue over the next 10
years.
Partnership Penalties
The law increases the monthly multiplier from $85 to $89 for the Code Sec. 6698(b)(1) failure-to-file
penalty applicable to partnership returns. This provision applies to returns filed after December 31, 2008,
and it is expected to raise an additional $42 million in revenue over the next 10 years.
Impact. Use of pass-through entities, in the form of both S corporations and partnerships, has more than
doubled over the past five years, as has income earned by them. As their use further increases, expect
Congress to utilize compliance issues related to them as fertile grounds for collecting new revenue.
President Signs the Housing and Economic Recovery Act of 2008
Reacting to the continuing slump in housing sales, along with rising unemployment numbers and
weakness in the credit markets, Congress passed the Housing and Economic Recovery Act of 2008 (H.R.
3221). Although the tax provisions are only one part of the larger housing bill, they make significant
changes. The tax title, The Housing Assistance Tax Act of 2008, includes $15.1 billion in tax incentives
that are fully offset by far-reaching revenue raisers. While the tax incentives are targeted principally to
home ownership and affordable housing, the offsets are collected from a variety of sources. New
provisions that require credit card purchase information reporting by merchants and close a home sale
exclusion loophole for vacation and rental property are among the more prominent offsets that will require
a shift in tax strategies.
Comment. With time running out before Congress' month-long August recess, the housing act took on
new life after amendments to shore-up Fannie Mae and Freddie Mac were added and the White House
removed its veto threat over the inclusion of a $4 billion community block grant provision. The bill passed
the House on July 23 by a vote of 272 to 152. After a procedural delay, the Senate approved it promptly
on July 26 by a vote of 72-13. President Bush signed the bill on July 30.
FIRST-TIME HOMEBUYER TAX CREDIT
The housing act gives first-time homebuyers nationwide a temporary refundable tax credit equal to 10
percent of the purchase price of a home, up to $7,500 ($3,750 for married individuals filing separately)
The credit begins to phase out for taxpayers with adjusted gross income in excess of $75,000 ($150,000
in the case of a joint return). The credit is effective for homes purchased on or after April 9, 2008, and
before July 1, 2009. Unlike other credits, however, the first-time homebuyer credit must be repaid in equal
installments over 15 years, essentially making it an interest-free loan from the government for most
qualifying homeowners.
Impact. The first-time homebuyer credit is by far the biggest tax break in the new law, weighing in at
an estimated cost of $4.8 billion over 10 years. However, that figure hides the credit's true immediate
impact since new homeowners are predicted to take this credit to the tune of $13.6 billion in 2009.
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Income limitations. The new credit phases out for married couples filing jointly with modified AGI
between $150,000 and $170,000 and for single taxpayers with modified AGI between $75,000 and
$95,000.
Impact. The IRS is not giving the $7,500 credit as cash at closing. The individual must claim the credit on
a 2008 or 2009 tax return. However, a first-time buyer who purchases a principal residence in 2009
after filing a 2008 return has the option of filing an amended 2008 return to claim the credit. Purchasers
also should investigate adjusting their wage withholdings or estimated tax payments for the balance of
the year to account for the credit.
First-time homebuyer. A person is considered a "first-time homebuyer" if he or she (or spouse) had no
ownership interest in a principal residence during the three-year period before the new home is
purchased.
Impact. Renters who also own a vacation home may qualify for the credit since the three-year look back
period for owning a home applies only to a principal residence.
Planning Note. Under the new law, two or more unmarried individuals may purchase a residence and
qualify for the credit. They must allocate the amount of the credit between them as the IRS prescribes.
However, the total amount of the credit allowed to the individuals jointly may not exceed $7,500.
Caution. The IRS will disallow the credit if the taxpayer disposes of the residence - or the residence
ceases to be the taxpayer's principal residence - before the close of the tax year for which the credit
would be allowed (either 2008 or 2009). The IRS will also disallow the credit if the taxpayer is a
nonresident alien, takes the expired, but likely to be renewed, District of Columbia first-time homebuyer
tax credit or the taxpayer's financing is from tax-exempt mortgage revenue bonds.
Repayment. Unlike any other individual federal tax credit, taxpayers must repay the first-time
homebuyer credit. They will have 15 years to repay the credit, interest free. Repayments start two years
after the year in which the residence is purchased. Payments must be made in equal installments over
those 15 years.
Example. Eduardo and Trisha, a married couple, are new homebuyers. They have never owned any
other real property as a residence. Their combined modified AGI is $66,400. Their first-time home
purchase qualifies for the full $7,500 credit. They purchase their home in June 2009. They may file an
amended 2008 return to claim the credit. Repayments of the $7,500 credit would begin at $500/year in
2010 and end in 2024.
Accelerated recapture. If a taxpayer sells or no longer uses the home as his or her principal residence
before repaying the credit, the unpaid balance becomes due in the year in which the residence is sold or
is no longer used as the taxpayer's principal residence. However, the amount of recaptured credit may
not exceed the amount of gain from the sale of the residence to an unrelated person.
Comment. The credit does not have to be repaid if the taxpayer dies. Special rules also exist for an
involuntary conversion and for a residence transferred in a divorce.
Purchase. "Purchase" as used in the new law occurs when title closes. In addition, homebuyers claiming
the credit may not acquire the property from certain related persons and they must satisfy certain basis
rules.
PROPERTY TAX DEDUCTION FOR NON-ITEMIZERS
Currently, only individuals who itemize deductions may deduct real property taxes imposed by state
and local governments. The new law gives non-itemizers a limited deduction for state and local real
property taxes by increasing the amount of their standard deduction by the lesser of:
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1. The amount of real property taxes paid during the year, or
2. $500 ($1,000 for a married couple filing jointly).
This temporary deduction is available only for 2008. Its cost over 10 years is $1.5 billion, all estimated to
be incurred in 2009.
Impact. Taxpayers most likely to benefit from this deduction include homeowners who have paid off their
mortgage (and, therefore, no longer itemize interest payments) and lower-income homeowners (whose
overall itemized deductions generally do not exceed their standard deduction).
Comment. For 2008, the $10,900 standard deduction for joint filers and surviving spouses would
increase to a maximum of $11,900, while the $5,450 standard deduction for single individuals increases
to a maximum $5,950 and the head-of-household amount from $8,000 to $8,500.
Impact. The new deduction is in addition to the standard deduction. It is not an above-the-line deduction
that lowers the amount of a taxpayer's AGI.
LOW-INCOME HOUSING TAX CREDIT
The housing act increases and simplifies the low-income housing tax credit (LIHTC).
The LIHTC program gives state and local housing agencies authority to issue tax credits for the
acquisition, rehabilitation or construction of lower-income rental housing. Credits are awarded to
developers of qualified projects. Developers sell these credits to investors to raise capital or equity for
their projects, which reduces the amount that the developer would otherwise have to borrow. Certain
expenses incurred in rehabilitating or purchasing an existing building can also qualify for the credit. The
credit is claimed over a 10-year period. The changes to the LIHTC are estimated to cost $1 billion over 10
years and would take effect in 2008.
Comment. The value of a LIHTC typically varies according to figures released monthly by the IRS. The
new law temporarily maintains the credit at nine percent for nonsubsidized new construction.
Impact. Residents of projects funded by the LIHTC program receive no direct subsidy. They benefit from
lower rents resulting from the LIHTC program.
Comment. Limited liability companies and limited partnerships are among the most widely used
ownership entities for purposes of the LIHTC.
Increase. Under the LIHTC program, each state receives an annual allocation of credits and each state's
allocation is capped. The current cap is $2.00 per resident multiplied by the state's resident population,
with a fixed minimum. The new law increases the cap to $2.20 per resident. There is also an increase in
the small-state set aside. This temporary increase in the annual volume cap applies only to 2008 and
2009.
Simplification. The LIHTC is extremely technical. The new law simplifies many provisions, including the
determination of area median gross income for purposes of the credit and annual recertification
requirements. The new law also modifies the definition of federally-subsidized housing, adds a third type
of high-cost area eligible for the LIHTC and increases certain minimum expenditure requirements for
rehabilitations.
TAX-EXEMPT HOUSING BONDS
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Tax-exempt housing bonds issued by state and local governments fund the acquisition, construction
and rehabilitation of affordable housing. The interest earned by the bondholder is exempt from federal
tax. The new law simplifies the rules for tax-exempt housing bonds and, in many cases, aligns the rules
to the ones governing the LIHTC. The new law also clarifies the tenant-income and rent-restriction tests
as well as the rules for student housing and single-room occupancy units. The estimated cost of the
changes to tax-exempt housing bonds is roughly $519 million over 10 years.
Comment. While income from private activity bonds is exempt from federal income tax, it may be
subject to state income tax.
Comment. Complex formulas govern whether a project qualifies for qualified private activity financing.
Generally, no fewer than 20 percent of the units in a multi-family dwelling must be occupied by
households earning 50 percent or less of the area median income, or no fewer than 40 percent of the
units must be occupied by households earning 60 percent or less of the area median income.
MORTGAGE REVENUE BONDS
State and local government housing finance agencies (HFAs) sell mortgage revenue bonds and use the
proceeds to finance below-market mortgages for qualifying first-time homebuyers. Income limits and
purchase price restrictions apply. The new law temporarily expands the mortgage revenue bond program
to permit the refinancing of existing subprime loans. The new law also authorizes states to issue an
additional $11 billion in mortgage revenue bonds for 2008 with a limited carry forward. The estimated cost
of the changes to mortgage revenue bonds is $1.475 billion over 10 years.
Impact. Many subprime borrowers are looking at an interest rate reset on their loans. Under the new law,
subprime borrowers may be able to use their state's mortgage revenue bond program to refinance into a
loan with a more favorable rate. A qualified subprime loan for purposes of the new law is an adjustable
rate single-family mortgage loan made after December 31, 2001, and before January 1, 2008, that the
bond issuer determines would be reasonably likely to cause financial hardship to the borrower if not
refinanced.
Planning Note. Expansion of mortgage revenue bonds to cover subprime loans would not apply to bonds
issued after December 31, 2010.
Comment. Generally, a first-time homebuyer for a state or local HFA program is an individual who has
not had an ownership interest in a principal residence for the past three years. However, individuals who
purchase homes in "targeted areas" may be treated as first-time homebuyers even if they have had an
ownership interest in a principal residence in the past three years. Additionally, the new law waives the
first-time homebuyer requirement for residences in Presidentially-declared disaster areas and treats these
disaster areas as "targeted areas."
REIT REFORMS
The new law includes a package of real estate investment trust (REIT) reforms. A REIT is a corporation or
trust created under state law that elects to be taxed as a REIT. A REIT holds passive investments in real
property and mortgages. An entity electing to be a REIT must satisfy complex organizational, distribution
and record-keeping requirements, along with source of income and asset holding tests. The REIT reforms
are estimated to cost $359 million over 10 years.
Impact. The majority of the new REIT provisions were proposed in 2007, before the real estate market
collapse. While current economics now make the argument even more compelling for these REIT
changes, they also are needed to maintain the REIT as a viable investment vehicle. U.S. REITs have
seen their market capitalization grow to over $300 billion over the past several years and are an essential
part of the revitalization of the housing market.
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Income tests. To qualify as a REIT for a tax year, at least 95 percent of the entity's gross income
must be "derived from" the types of income listed in Code Sec. 856(c)(2) and at least 75 percent of its
gross income must be "derived from" the types of income listed in Code Sec. 856(c)(3), which include real
estate-related income. However, gains from foreign currency exchanges are not specifically enumerated
in these sections. Under the new law, specified foreign currency gains would be treated as qualified
income for purposes of the income tests.
The new law also clarifies when Code Sec. 987 currency gain recognized by a REIT from a qualified
business unit (QBU) of the REIT is treated as qualifying income and makes other changes to the rules
governing foreign currency gains or losses.
REIT subsidiaries. A REIT may avoid disqualified rents by using taxable REIT subsidiaries to conduct
certain activities. With two exceptions, amounts paid by a taxable REIT subsidiary to a REIT will be
disqualified if the REIT owns 10 percent or more of the subsidiary. One exception involves qualified
lodging facilities. The new law extends this exception to health care facilities operated by an independent
contractor on behalf of the taxable REIT subsidiary.
The new law also increases the percentage of assets that can be held in securities of the taxable REIT
subsidiary from 20 percent to 25 percent.
Safe harbors. If a REIT realizes net income from a prohibited transaction, a tax equal to 100 percent
of the net income is imposed. Under an existing safe harbor, the sale of property that is held for sale to
customers is not a prohibited transaction if, among other things, the property has been held by the REIT
for a minimum of four years. The new law shortens this period from four to two years and further refines
the safe harbor concerning the maximum number of sales within a tax year. This is the only revenue
raiser in the group of REIT reforms, forecast to take in $54 million over the next 10 years.
Comment. The changes in the new law impacting REITs would be generally effective for tax years
beginning after the date of enactment.
MORE INCENTIVES/TAX BREAKS
AMT/R&D credits. The new law allows corporations to use accumulated alternative minimum tax
(AMT) and research and development (R&D) credits by electing not to claim the special 50-percent bonus
depreciation allowed under the Economic Stimulus Act of 2008 (P.L. 110-185). The amount of unused
credits that may be claimed are limited to 20 percent of the difference between depreciation allowed if the
bonus deduction is claimed and depreciation without the bonus deduction. The increased credits are
refundable. The amount claimed is limited to the lesser of $30 million or six percent of the total credits
accumulated from 2005 and earlier years. The bonus depreciation must be based on property that is
originally used, purchased, and placed in service after March 31, 2008, and before January 1, 2009
(January 1, 2010 for certain longer-lived and transportation property).
Impact. The Economic Stimulus Act included two business tax incentives: enhanced Code Sec. 179
expensing and special bonus depreciation. Unlike previous stimulus packages, it did not give taxpayers
an extended loss carryback, which would give companies in a loss position an immediate cash infusion.
Moreover, companies in a loss position cannot take advantage of special bonus depreciation because
they do not have any taxable income against which to take the deductions.
Impact. Forgoing 50-percent bonus depreciation on property acquired after March 31, 2008, does not
mean that depreciation over the life of the asset will be any less. Bonus depreciation simply accelerates
depreciation and forgoing it, therefore, only delays the depreciation of that asset. However, if a
corporation makes this election, the MACRS straight-line depreciation method must be used.
Tax-exempt bonds. More than 20 years ago, Congress prohibited federal guarantees of tax-exempt
bonds issued by state and local governments, with exceptions for Fannie Mae, Freddie Mac and other
specified entities. The new law extends this exception to federal home loan banks at an estimated cost of
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$126 million over 10 years.
Impact. The change should lower borrowing costs and make more financing available for state and local
government infrastructure projects.
AMT limitations. The new law excludes tax-exempt interest on certain housing bonds from being a
preference item for AMT purposes. It also allows taxpayers to use the LIHTC and the rehabilitation tax
credit to offset AMT liability.
Rehabilitation tax credit. The rehabilitation tax credit is a two-tier credit. Generally, the credit is 20
percent for qualified rehabilitation expenditures of certified historic structures and 10 percent for buildings
placed in service before 1936. If more than 35 percent of a rehabilitated building is leased to a state or
local government, the credit is unavailable. The new law increases this threshold to 50 percent.
Comment. The amounts are temporarily higher for qualifying property in the Gulf Opportunity (GO) Zone
to help restoration efforts after Hurricane Katrina.
Social Security numbers. The Foreign Investment in Real Property Tax Act (FIRPTA) requires
sellers of real property to sign an affidavit stating they are not nonresident aliens or they must be subject
to withholding. The affidavit includes the seller's taxpayer identification number (TIN) - which for most
individuals is their Social Security number. Under the new law, sellers may provide the affidavit to the title
or escrow company facilitating the closing of the sale to protect the privacy of their Social Security
number.
GO Zone incentives. After Hurricane Katrina devastated the Gulf Coast, Congress passed a package of
tax incentives to help individuals and businesses rebuild. The new law enhances and extends some
of those incentives.
Economic stimulus payments. The new law includes a housekeeping provision authorizing the
Treasury Department to transfer funds among different accounts to carry out the 2008 economic stimulus
payments.
Down payment assistance programs. The new law bans seller-funded down payment assistance
programs (DAPs). DAPs have been criticized for contributing to the record-high number of foreclosures.
In 2006, the IRS announced that organizations providing seller-financed down payment assistance to
homebuyers do not qualify as tax-exempt charities (Rev. Rul. 2006-27).
Military personnel. The new law temporarily enhances certain protections against foreclosure under the
Servicemembers Civil Relief Act, along with special interest rate caps. Mortgage lenders must, at the
request of the service member, reduce the interest rate to no more than six percent per year during the
period of active military service and recalculate the payments to reflect the lower rate.
OFFSETS
Congress had to find a way to pay for the new tax incentives. The largest offset in the housing act
requires information reporting on merchant payment card transactions. Other offsets include: new limits
on the home sale exclusion, a delay in the worldwide interest allocation rules and an acceleration of
estimated tax payments for large corporations.
CREDIT CARD INFORMATION REPORTING
Under the new law, banks and other processors of merchant payment card transactions (credit and debit
cards) will be required to report a merchant's annual gross payment card receipts to the IRS (and to the
merchant). The new law also requires reporting on third-party network transactions (such as ones used
by many online retailers). Merchants and payment card processors have time to prepare. The new
treatment is effective for sales made on or after January 1, 2011.
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Impact. The "paper trail" created by payment cards is currently unavailable to the IRS except on a case-
by-case basis. The new law changes this. According to the Treasury Department, expanded information
reporting will assist the IRS in increasing the compliance rate among merchants. It plans to compare the
merchant's overall volume of payment card sales in relation to expenses claimed and cash transactions
reported. The new reporting is estimated to raise more than $9.5 billion.
Impact. Many small businesses were opposed to expanded payment card information reporting, warning
that the high costs of credit and debit transactions are already driving many merchants away from these
transactions.
De minimis exception. The new law creates an exception from information reporting if the aggregate
value of third party network transactions does not exceed $20,000 for the calendar year or the aggregate
number of these transactions does not exceed 200.
Comment. Among the issues that the IRS will have to address in regulations are charge-backs (where a
merchant is debited for the amount that a credit card company refunded to a customer when the
customer returns a purchase) and transactions in which the customer receives "cash back" as well as
merchandise.
Comment. The new law requires the reporting party to provide the IRS with the merchant's TIN. If the
reporting party cannot provide this information, it would be required to withhold at 28 percent the
payments to the merchant. Typically, backup withholding is imposed on income, such as interest or
dividends, with no offsetting deductions. Here, it would apply before the merchant deducts any offsetting
expenses.
REDUCED HOME SALE EXCLUSION
Gain from the sale of a principal residence home will no longer be excluded from gross income under
Code Sec. 121 for periods that the home was not used as the principal residence ("non-qualifying use").
This new income inclusion rule applies to home sales after December 31, 2008, and, under a generous
transition rule, is based only on nonqualified use periods that begin on or after January 1, 2009. In
further relief from this new loophole closer, a period of absence generally counts as qualifying use if it
occurs after the home was used as the principal residence.
Impact. The rule prevents use of Code Sec. 121's exclusion of gain from the sale of a principal residence
of up to $250,000 ($500,000 for joint filers) for appreciation attributable to periods after 2008 during which
a residence was used as a vacation home or as rental property before its use as the principal residence.
Comment. Rather than require a valuation of the property on January 1, 2009, or at the time use is
converted into a principal residence, however, the new law determines excluded appreciation on a pro-
rata basis.
The amount of gain allocated to periods of nonqualified use is the amount of gain multiplied by a fraction,
the numerator of which is the aggregate period of nonqualified use during which the property was owned
by the taxpayer and the denominator of which is the period the taxpayer owned the property.
"Nonqualified use" for this computation does not include any use prior to 2009.
Example. Adam buys property on January 1, 2009, for $400,000 and rents it for two years, claiming
$20,000 of depreciation. On January 1, 2011, Adam begins to use the property as his home. Adam
moves out of the house on January 1, 2013, and sells it for $700,000 on January 1, 2014. The period
2009-2010 is non-qualifying use. The year 2013, after Adam moved out, is treated as qualifying use. Of
the $300,000 gain, 40 percent (two years out of five years owned), or $120,000 is not eligible for the
exclusion. The balance of the gain, $180,000, may be excluded. The $20,000 gain attributable to
depreciation is recaptured, as required under current law.
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WORLDWIDE INTEREST ALLOCATION
The American Jobs Creation Act of 2004 (P.L. 108-357) allows an affiliated group of corporations to elect
global interest expense allocation starting in 2009. The election applies to future years unless it is
revoked with IRS consent. An affiliated group may make a one-time election to determine foreign-source
taxable income of the group by allocating and apportioning interest expense of the domestic members of
a worldwide affiliated group on a worldwide group basis, as if all members of the worldwide group were a
single corporation. The new law delays the worldwide interest allocation rules in the 2004 Jobs Act until
tax years beginning after December 31, 2010. This change is effective as of the date of enactment of the
new law. A transition rule reduces the benefit in 2011, the first year of the change.
Impact. The global interest allocation results in more interest being allocated to U.S.-source income
under the foreign tax credit formula, increasing the credit limitation.
CORPORATE ESTIMATED TAX PAYMENTS
Like recent tax bills, the new law accelerates certain corporate estimated tax payments for
corporations with assets of at least $1 billion. Payments due in July, August and September 2013 are
increased by 16.75 percent. Payments due in October, November and December 2013 would be reduced
by an offsetting amount. However, accelerated payments scheduled for July, August and September
2012 by previous tax legislation are repealed.
Impact. The change would maximize the five-year revenue impact of the increased payments.
MORE LEGISLATION
The urgency with which lawmakers acted on the housing bill has not yet carried over to other pending
tax legislation, especially the extenders bill (a package of popular but temporary tax incentives, such as
the state and local sales tax deduction, teachers' classroom expense deduction, research tax credit, and
employer tax credits). Lawmakers also appear unable at press time to break the current deadlock over
how to pay for this year's alternative minimum tax (AMT) "patch," especially now that a major candidate
for offsetting the cost of a patch - merchant payment card information reporting - has been included in the
Housing Assistance Tax Act.
October 3, 2008
President Signs Financial Markets Rescue Plan, AMT Patch, Extenders, Disaster Relief And More
After a tumultuous week, Congress passed and President Bush signed a historic financial markets rescue
bill that includes over 100 tax provisions and over $150 billion in separate tax breaks. The Emergency
Economic Stabilization Act of 2008 cleared the Senate on October 1 by a 74-25 vote, followed by a nail-
biting 263-171 vote in the House on October 3. The president signed the bill into law at the White House
on the same day.
In addition to the major tax provisions that directly address current financial bailout measures, the
new law includes a much-anticipated alternative minimum tax (AMT) patch, an extensive package of tax
extenders, energy incentives, disaster relief, and more. The Emergency Economic Stabilization Act's
$150 billion in tax incentives impacts both individuals and businesses. Approximately $44 billion in
offsets, however, mean tax increases for certain groups.
Comment. A version that contained only rescue plan provisions failed in the House on September 29.
The Senate then took the lead, gambling on linking the AMT patch, extenders, and disaster relief to the
rescue plan, and won.
Planning Tip. Although the new law's primary purpose is to solve the credit crunch in the financial
markets, it also serves as one of the largest tax bills in recent years. The new law makes almost 300
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changes to the Internal Revenue Code. While roughly $150 billion in tax breaks had to be computed over
a requisite 10-year period for budget scoring purposes, the lion's share of that outlay provides taxpayer
relief immediately in 2008 and 2009. Consequently, year-end tax planning takes on a special urgency this
year to maximize taxpayer use of these new tax breaks both before 2008 ends and immediately at the
start of 2009.
FINANCIAL MARKETS RESCUE PLAN
Marathon negotiations between House and Senate lawmakers ended in the financial markets rescue plan
(the Troubled Assets Relief Program (TARP)) as one of the main components in the new law. The rescue
package includes three major tax-related provisions.
Comment. TARP has two tracks: the direct purchase program and the auction program. The new law
authorizes the government to make direct purchases of troubled assets. Alternatively, the government
may acquire them through auction purchases.
Executive Compensation
Lawmakers took a two-prong approach to curbing excessive executive compensation within those
companies directly assisted by the government. In a direct purchase situation, compensation standards
will be set by the Treasury Department. The rescue package also limits the deductibility of compensation
under Code Sec. 162(m) to $500,000 for CEOs, CFOs, and other executives of qualifying companies
participating in TARP auctions, if the company has sold $300 million or more in assets.
Comment. Lawmakers also voted to rein in so-called golden parachutes paid to departing executives.
Companies participating in TARP auctions must agree to limit golden parachutes payments; any amounts
above that amount will be subject to an excise tax. In a direct-purchase situation, golden parachutes
are prohibited.
Impact. Congress also gave the Treasury Department "clawback" power in a direct-purchase situation.
The government may recover a bonus or other incentive paid to a senior executive of a company
participating in the rescue package that had been paid based on statements of earnings, gains or other
criteria that later are shown to be materially inaccurate.
Fannie and Freddie Stock Losses
Under the rescue plan, community banks and other qualifying financial institutions that hold preferred
stock in Fannie Mae and Freddie Mac may treat their Fannie Mae and Freddie Mac losses as ordinary
losses. This treatment applies to preferred stock that was held on September 6, 2008 or sold or
exchanged on or after January 1, 2008, and before September 7, 2008.
Caution. This treatment is only available to community banks and other eligible financial institutions. It is
not available to individuals. Additionally, Congress authorized the Treasury Secretary to expand the
application of this provision for certain property not held on September 6, 2008.
Extended Exclusion for Homeowners
The rescue plan extends a temporary rule for cancellation of indebtedness income. When a lender
forecloses on property, sells the home for less than the borrower's outstanding mortgage and forgives all
or part of the excess mortgage debt, the tax code treats the cancelled debt as taxable income to the
homeowner. The Mortgage Forgiveness Debt Relief Act, enacted in late 2007, excludes from federal tax
those discharges involving up to $2 million of indebtedness ($1 million for a married taxpayer filing a
separate return) secured by a principal residence and incurred in the acquisition, construction or
substantial improvement of the residence. The new law extends this treatment from the end of 2009
through 2012.
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Comment. The Mortgage Forgiveness Debt Relief Act also helps homeowners whose mortgage debt
may have been reduced through a restructuring (also known as a mortgage workout). Short sales and
deeds-in-lieu-offoreclosure are also covered by the extension.
AMT PATCH
Congress included an alternative minimum tax (AMT) patch in the new law. Under the new law's
patch for the 2008 tax year, the AMT exemption amounts are $69,950 for married couples filing jointly
and surviving spouses, $46,200 for single taxpayers and heads of household, and $34,975 for married
couples filing separately for 2008.
Impact. The patch is designed to insulate middle-income taxpayers from the reach of the AMT. The AMT
patch will cost $61.8 billion when measured against what would have been collected without it.
Reminder. The patch is only for 2008. Hopes are high that in 2009 Congress finally will face up to the
need to find a permanent solution to the AMT and pass AMT reform rather than yet another patch.
Nonrefundable Personal Credits
The patch allows taxpayers to take nonrefundable personal credits to reduce their AMT liability. The law
also removes limits in the AMT on taking personal credits against regular tax liability.
Comment. Personal credits include the dependent care credit and education tax credits. The
adoption, child and saver's credit were already allowed in full against the AMT and regular tax.
Incentive Stock Options
The new law provides relief to those high-tech workers and others who were left holding worthless stock
options but a large tax bill based on AMT calculations when the tech industry collapsed. The new law
will abate AMT liability stemming from the exercise of incentive stock options (ISOs) before 2008,
effective for any unpaid tax liability on the law's date of enactment. Interest and penalties on the unpaid
amounts would also be abated.
Comment. In September 2008, the IRS announced that it was temporarily suspending collection of ISO
AMT in anticipation of Congress taking action.
The law allows all individuals, including those who paid their ISO AMT liabilities, to accelerate the refund
of the minimum tax credit that has not been used. The law also increases the minimum tax credit by
50 percent of any interest and penalties paid before the date of enactment.
INDIVIDUAL INCENTIVES
Tax relief for individual taxpayers in the new law primarily comes in the form of a handful of popular
"extenders." These encompass tax breaks that, for many taxpayers, have been considered as permanent
provisions because of the expectation of automatic renewal every year or two.
State and Local Sales Tax Deduction
The American Jobs Creation Act of 2004 and subsequent legislation allowed individuals to deduct state
and local general sales taxes in lieu of state and local income taxes. This deduction expired at the
end of 2007. The new law makes the deduction retroactive for 2008 and extends it for two years through
December 31, 2009.
Reminder. Taxpayers can calculate their deduction either by saving receipts or using the Optional State
Sales Tax Tables provided by the IRS.
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Higher Education Tuition Deduction
The new law extends through December 31, 2009, the above-the-line higher education tuition
deduction. The deduction allows eligible taxpayers to deduct the costs of qualified higher education
expenses paid during the year for themselves, a spouse, or a dependent.
Comment. The deduction continues to be barred to taxpayers whose filing status is married filing
separately, or if another person can claim an exemption for the taxpayer as a dependent on his or her
tax return.
Impact. The maximum deductible amount is $4,000 for taxpayers with adjusted gross income not
exceeding $65,000 ($130,000 for joint filers). Taxpayers whose income exceeds that limit but does not
exceed $80,000 ($160,000 for joint filers) may deduct up to $2,000 in qualified expenses. For many
taxpayers, the HOPE or Lifetime Learning credit is also an option.
Additional Standard Deduction Real Property Taxes
The new law extends the additional standard deduction for real property taxes for non-itemizers
through 2009. Congress authorized a maximum $500 additional standard deduction ($1,000 for joint
filers) in the Housing Assistance Tax Act of 2008 but made it available only for the 2008 tax year.
Reminder. The deduction is in addition to the standard deduction. It is not an above-the-line deduction
that lowers a taxpayer's adjusted gross income (AGI). For 2008, the $10,900 standard deduction for joint
filers will increase to a maximum of $11,900 with the additional standard deduction for non-itemizers,
while the $5,450 standard deduction for single individuals will increase to a maximum $5,950, and the
head-of-household amount from $8,000 to $8,500.
Teachers' Classroom Expense Deduction
For 2008 and 2009, teachers and other education professionals can deduct, above-the-line, up to
$250 of certain out-of-pocket classroom expenses, including the cost of books, supplies, equipment, and
software used in the classroom. First introduced in 2002, this deduction is available to qualified educators
regardless of whether or not they itemize their deductions.
Comment. Expenses that exceed $250 and non-classroom supplies may be deducted as an
employment-related miscellaneous itemized deduction subject to the two-percent floor for taxpayers who
itemize.
Tax-Free Distributions from IRAs for Charitable Purposes
The new law permits taxpayers to make tax-free distributions from IRAs for charitable purposes
through December 31, 2009. This popular charitable contribution option had expired January 1, 2008.
The maximum contribution limit for 2008 and again for 2009 is $100,000.
Impact. This treatment applies to traditional and Roth IRAs. However, no charitable deduction is allowed
for any portion of these withdrawals that would have been otherwise taxable.
More Individual Incentives
The new law also extends:
Treatment of certain dividends of Regulated Investment Companies (RICs)
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Estate tax look-through for RIC stock held by nonresidents
Qualified investment entities treatment
CHILD TAX CREDIT
The new law enhances the child tax credit. The credit is currently refundable to the extent of 15
percent of the taxpayer's earned income in excess of approximately $12,050 (reflecting inflation
adjustments from the original floor of $10,000). Under the new law, the floor falls to $8,500.
BUSINESS TAX INCENTIVES
The new law includes a host of incentives targeted to businesses, several of which revise as well as
extend tax benefits. Among the most significant are revised research tax credit, enhanced
depreciation for leasehold and restaurant improvements, and brownfields remediation.
Research Tax Credit
The new law extends the research tax credit to amounts paid or incurred in 2008 and 2009. It also
modifies the credit, increasing the alternative simplified credit while repealing the alternative incremental
research credit.
Comment. Congress first created the alternative simplified credit in 2006. The credit was 12 percent of
qualified research expenses that exceed 50 percent of the average qualified research expenses for the
three preceding tax years. The new law raises the percentage to 14 percent and makes some
technical corrections.
Leasehold and Restaurant Improvements
Under the new law, qualifying restaurant improvements and leasehold improvements will be eligible for
15-year cost recovery rather than a 39-year period for two more years, through December 31, 2009.
Similarly, Congress authorized a 15-year recovery period for depreciation of certain improvements to
retail space. This treatment is extended through December 31, 2009.
Impact. The treatment applies to both owner-occupied businesses and restaurants, as well as leased
establishments.
Charitable Contributions
The Tax Code gives businesses enhanced deductions for contributions of food to charitable
organizations, as well as contributions of books and computer equipment to qualifying schools. The new
law extends these tax breaks through December 31, 2009. Additionally, Congress extended the
temporary suspension of limitations on charitable contributions in the case of a qualified farmer or rancher
contributing food before January 1, 2009.
Comment. S corp shareholders are also eligible for special tax treatment when making charitable
contributions of qualifying property. The new law extends the special rule allowing S corp shareholders to
take into account their pro-rata share of charitable deductions even if such deductions would exceed such
shareholder's adjusted basis in the S corp through December 31, 2009.
New Markets Tax Credit
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The new law extends the New Markets Tax Credit through December 31, 2009.
Impact. The New Markets Tax Credit is one of the few incentives in the Tax Code to encourage
taxpayers to invest in or make loans to small businesses in economically distressed areas. In today's
credit crunch, extension of the New Markets Tax Credit may help small businesses secure financing that
otherwise would not be available.
Hurricane Katrina Relief
After Hurricane Katrina devastated the Gulf Coast, Congress passed a package of tax incentives to
help individuals and businesses recover. One provision enhanced the Work Opportunity Tax Credit for
Hurricane Katrina-affected employers. The new law extends this provision through 2009. Another Katrina-
related incentive, the increased rehabilitation credit for structures in the Gulf Opportunity Zone, is also
extended through 2009.
More Business Extenders
The new law also extends:
Seven-year straight-line cost recovery period for motorsports entertainment complexes
The Code Sec. 199 domestic production activities deduction for qualifying activities in Puerto Rico
Cover over of rum excise tax to Puerto Rico and the U.S.V.I.
Qualified Zone Academy Bonds
Mine rescue training team credit
Railroad track maintenance credit
Election to expense mine safety equipment
District of Columbia first-time homebuyer tax credit
Indian employment credit; and over 10 more targeted extenders
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ENERGY
The new law extends a host of energy tax incentives, some targeted to consumers and others to
producers and manufacturers. Many of the extensions go beyond the one or two year periods that
Congress authorized for non-energy extenders.
Energy Efficiency and Property
The new law extends several energy-efficiency and energy property tax incentives. The Code Sec.
179D deduction for energy efficient commercial buildings is extended through December 31, 2013. The
Code Sec. 25D residential energy efficient property credit is extended through December 31, 2016, along
with adding incentives for residential small wind investment and geothermal heat pumps and authorizing
taxpayers to use the credit to offset AMT. Congress also reinstated the Code Sec. 25C residential energy
property credit for property placed in service in 2009. Additionally, Congress modified the energy efficient
appliance credit for manufacturers of qualifying dishwashers, clothes washers, and refrigerators.
Impact. The energy incentive impacting most individuals is the Code Sec. 25C credit for the purchase of
residential energy property. A credit of up to $500 is available for nonbusiness energy property that meets
the requirements for qualified energy efficiency improvements or qualified residential energy property
expenditures. Eligible improvements include insulation materials, exterior windows, including skylights
and exterior doors.
Renewable Energy
Included in the new law are several extended incentives to encourage the production of renewable
energy. Congress extended the credit for producing electricity from qualified wind facilities through
December 31, 2009, and the credits for producing electricity through biomass and other qualifying
renewable sources through September 30, 2011. The credit for solar energy, fuel cell, and microturbine
property is extended through December 31, 2016.
Impact. The new law expands the definition of some of the renewable energy sources, such as biomass,
enabling more producers to qualify for the tax incentives. To close a loophole, biodiesel fuel that is
imported and immediately sold for export is ineligible for the tax incentive retroactive to May 15, 2008.
Transportation Fringe Benefit
Employees can exclude certain employer- provided transportation fringe benefits from income, such as
transit passes and van pooling. The new law extends this treatment to employer-provided transportation
fringe benefits paid to employees who commute by bicycle. The exclusion amount is $20 per month. This
treatment is effective for tax years beginning after December 31, 2008.
More Energy Incentives
Other energy provisions relate to:
Coal gasification investment credit
Clean renewable energy bonds
Steel industry fuel
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Alternative fuels credit
Alternative refueling stations credit
Percentage depletion for marginal wells
Refinery expensing
Excise tax on coal to fund Black Lung Disability Trust
Plug-in electric drive vehicles
Non-hydrogen alternative fuel refueling property
Comment. Congress also authorized a refund of coal excise taxes that the IRS collected from
exporters, which the Supreme Court has deemed unconstitutional.
DISASTER RELIEF
The new law provides temporary, but significant, tax relief to victims of the severe storms, tornadoes,
and flooding that swept through the Midwest in 2008 and - to a lesser extent - victims of Hurricane Ike in
Texas. Additionally, Congress authorized national relief for locations declared disaster areas by the
president in tax years beginning after December 31, 2007, with some exceptions.
Caution. The Midwestern Disaster Area encompasses presidentially- declared disaster areas in
Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, and Wisconsin
between May 20, 2008, and before August 1, 2008. The Hurricane Ike Disaster Area encompasses parts
of Louisiana and Texas, which were declared disaster areas by the president on September 13, 2008.
Midwestern Disaster Area
The tax incentives in the Midwestern Disaster Area mirror many of the ones enacted in 2005 after
Hurricanes Katrina, Rita, and Wilma devastated the Gulf Coast. These include increased expensing for
demolition, environmental remediation, and clean-up costs, enhanced depreciation for qualified disaster
property, education, and housing tax benefits, and a higher standard mileage rate for charitable use of
vehicles.
Hurricane Ike Disaster Area
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The incentives targeted to the Hurricane Ike Disaster Area are much more limited than the incentives for
the Midwestern Disaster Area. Congress authorized temporary tax-exempt bond financing and low-
income housing tax relief for certain areas damaged by Hurricane Ike.
Comment. Victims of Hurricane Ike may be eligible for national disaster relief (discussed below).
National Disaster Relief
Taxpayers affected by natural disasters (after December 31, 2007, and before January 10, 2010, with
some exceptions) may be eligible for increased expensing for qualified disaster expenses, special
depreciation for qualified disaster property enhanced NOL carryback, and other targeted tax breaks.
RETURN PREPARER STANDARD
The Small Business and Work Opportunity Tax Act of 2007 (2007 Small Business Tax Act) replaced
the "realistic possibility of success standard" in Code Sec. 6694(a) with the heightened "more likely than
not standard" for undisclosed, nonabusive positions. The new law removes the more likely than not
language under Code Sec. 6694(a) and replaces it with substantial authority. This change is retroactive to
the effective date of the 2007 Small Business Tax Act.
Impact. The IRS was expected to issue final regulations reflecting the more likely than not standard
under Code Sec. 6694(a) before the end of 2008. However, the new law essentially makes these
regulations unnecessary.
Comment. The new law retains the more likely than not standard for tax shelters and reportable
transactions.
OFFSETS
The new law includes more than $43 billion in revenue raisers, which only partially offset the cost of the
extenders and other tax provisions. One of the most expansive offsets is broker basis reporting.
Another offset plugs a foreign deferred compensation loophole and still another extends an employment
surtax.
Broker Basis Reporting
Reporting by brokers has been expanded. Brokers must report the adjusted basis of publicly-traded
securities when reporting sales transactions and indicate whether gain is long-term or short-term.
Securities subject to the new reporting requirement include stock, bonds, debentures, commodities,
derivatives, and other financial instruments designated by Treasury. Reporting will take effect for stock
acquired in 2011, mutual funds acquired in 2012, and other securities acquired in 2013. The provision is
estimated to raise $6.7 billion over 10 years.
Comment. Brokers will use the first-in, first-out (FIFO) method or the average cost method to determine
basis, unless the taxpayer provides specific identification of the securities being sold.
Foreign Deferred Compensation
Nonqualified deferred compensation plans maintained by foreign corporations will generally become
taxable, unless the compensation is deferred 12 months or less after the end of the year that the
compensation vests. The tax can also apply to partnerships with foreign partners. Deferred
compensation will be taxable when the amount is determinable. If the compensation is not determinable
when it is deferred, the individual must pay a 20 percent surtax, plus interest, when the amount is
determinable. The law applies to compensation for services performed after 2008 and is expected to raise
$25 billion.
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Comment. This provision is aimed at compensation schemes for executives who are paid by an entity
that is located in a low- or no-tax jurisdiction and is "indifferent" to the arrangement because it is not
losing a deduction when it defers the income. The provision does not apply to an entity whose income is
taxable in the U.S. or subject to a "comprehensive foreign income tax."
Code Sec. 199 Deduction
Under the new law, the Code Sec. 199 domestic production activities deduction is capped at six percent
for oil and gas production. The limit applies to "oil-related qualified production activities income (QPAI)."
This includes income from the production, refining, processing, and transportation or distribution of oil or
gas, or any primary product of oil and gas. The cap is expected to raise $4.9 billion over 10 years.
Comment. The deduction for all eligible taxpayers is currently six percent of QPAI. The deduction is
scheduled to increase to nine percent in 2010 for all taxpayers except for taxpayers with oil-related QPAI.
Foreign Tax Credits
The law tightens the rules for oil and gas companies to pay taxes on overseas income. It eliminates
the distinction between foreign oil and gas extraction income (FOGEI) and foreign oil-related income from
transportation and refining and applies the FOGEI foreign tax credit limitation (Code Sec. 907) to income
from oil and gas production and sales. The provision takes effect in 2009 and is expected to raise $2.2
billion over 10 years.
Oil Spill Tax
The oil spill liability trust fund tax has been extended through 2017. The tax will increase from five
cents per barrel to eight cents per barrel through 2016 and rises to nine cents in 2017. Congress
eliminated the provision that suspends the tax when the trust's unobligated balance reaches $2.7 billion.
The change in treatment takes effect in the first quarter that is more than 60 days after enactment of the
law and is expected to raise $1.7 billion.
FUTA Surtax
The law extends the 0.2 percent surtax on FUTA (unemployment) taxes for one year, through 2009.
FUTA tax is 6.2 percent of wages. The change is expected to raise $1.5 billion. The tax is imposed on
the first $7,000 paid to each employee.
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