NEW TAX LAW & PROVISIONS FOR 2009 & BEYOND

On February 26, President Obama released his 2010 federal budget proposal totaling a record $3.55 trillion. Entitled "The New Era of Responsibility," President Obama's budget contains a minimum of $1 trillion in tax increases over the next decade on higher earners, described as families making over $250,000 and individuals earning over $200,000. It also includes revenue-raising "loophole closers" (most of them aimed at businesses), some favorable tax changes for businesses, higher taxes for "higher-income individuals," and tax cuts for other individuals. Here is an overview of the tax elements of the proposed budget. Not all of the proposed changes were clear, so we had to read between the lines in some cases.

REMEMBER: These are proposals and not yet signed into law - they may or may not come about!

• Child Tax Credit – Make permanent the Recovery Act's liberalized child tax credit rules, which under current rules apply for 2009 and 2010 only - reduced the earned income threshold to $3,000 from the current $12,550 (2009), thus expanding the number of taxpayers who qualify for the refundable portion of the credit.

• High-Income Taxpayers - $250,000 (married) and $200,000 (single) – The following changes would be proposed to apply to married taxpayers earning over $250,000 and single taxpayers earning over $200,000:

o Personal Exemption Phase-Out Restored – Reinstate the personal exemption phase-out and limitation on itemized deductions (2011).

o Raise the Rates on the Two Top Tax Brackets – Raise the top two income tax rates starting in 2011 to 36% and 39.6% from 33% and 35%, respectively.

o Limit the Benefit of Itemized Deduction to 28% – Limit itemized deductions for those in the new 36% and 39.5% tax brackets to the same after-tax benefit as those individuals in the 28% bracket.  Although no detailed information is available and no proposed starting date has been indicated, it would seem that this limitation would apply only to the itemized deductions in excess of the standard deduction for the year and the excess would be reduced by the percentage difference between the taxpayer’s actual tax bracket and 28%.  Sounds a little complicated – so much for simplification.   

o Increased Capital Gains Rate – Beginning in 2010, those in new 36% and 39.5% tax brackets would also be subject to an increased capital gains and dividends tax of 20%, up from 15%.  Presumably, the computation would be similar to the current one and the increase would only be on gains in falling within the two new top brackets, 36% and 39.5%.

• Estate Tax Rates – For 2009, the estate tax rules have a $3.5 million exemption and a top rate of 45%.  They were scheduled to be zero for 2010 and then revert to the 2001 rates.  It is expected the President will push for an extension of the 2009 rates. 

• Making Work Pay Tax Credit – The Making Work Pay Credit was part of the Recovery Act of 2009.  It provides for a credit equal to 6.2% of a taxpayer’s earned income not to exceed $400 for individuals and $800 for joint filers with an AGI phase-out for higher-income taxpayers.  The credit would become permanent in 2011.  
 
• American Opportunity Tax Credit – Make permanent the 2009 Recovery Act's “new American Opportunity tax credit” for higher education expenses, which under current rules applies for 2009 and 2010 only.  The American Opportunity credit is available for four years of college, and the maximum credit per student is $2,500.  The credit is based on 100% of the first $2,000, and 25% of the next $2,000, of tuition, fees and course material (including books) expenses paid during the tax year.  40% of the credit is refundable, provided the taxpayer is: (1) not a child under the age of 18 or (2) under the age of 24, a full-time student and is not self-supporting.

• Earned Income Tax Credit - Eliminate the Advanced Earned Income Tax Credit beginning in 2010.

• Automatic Enrollment - Workplace Pensions – Beginning in 2011, the administration also proposes establishing “automatic workplace pensions, on top of and clearly outside Social Security.  Employees would be automatically enrolled in workplace pension plans (unless they opt out).  Those employers not offering retirement plans would be required to enroll their employees in a direct deposit IRA (but employees apparently would be given an opt-out option).

• Saver's Credit - The President’s proposal also allots $14 billion for an expanded Saver's Credit program beginning in 2011 and provides the groundwork for the establishment of an automatic direct deposit individual retirement accounts program to be developed by the Labor Department.  The program would require employers to automatically enroll employees in a direct deposit plan unless they choose to opt out. 

Proposed Business Changes

• Research Tax Credit - Make the research tax credit permanent beginning in 2010.

• NOL Carry Back - Expand the net operating loss carry back beginning in 2011.
 
• Qualified Small Business Stock - Eliminate capital gains taxation on small business beginning in 2014.  The Recovery Act has already increased the exclusion from 50% to 75% for stock issued after February 17, 2009 and before January 1, 2011.

• LIFO - Repeal LIFO beginning in 2012.

• Economic Substance Doctrine - Codify the economic substance doctrine beginning in 2009.  Generally, the economic substance doctrine is satisfied only if (1) the transaction changes in a meaningful way (apart from federal income tax consequences) the taxpayer's economic position, and (2) the taxpayer has a substantial non-federal tax purpose for entering into such transaction.  There are substantial penalties for not meeting this requirement and failure to disclose it.

• Rental Income Tracked - Require information reporting for rental payments beginning in 2010.

• Carried Interest - Tax carried interest as ordinary income effective in 2011.

• Superfund Taxes - Reinstate Superfund Taxes in 2011.

• Repeal Oil & Gas Tax Breaks – Beginning in 2011, repeal all of the following oil and gas tax breaks: 

o Expensing of intangible drilling costs;
o Percentage Depletion (2011);
o Passive Loss Exception for Working Interests in Oil and Gas Properties;
o Manufacturing Deduction for Oil and Gas Companies; and
o Deduction for Tertiary Injectants.

After months of negotiations, the California legislature has passed a budget deal that includes a number of tax increases for just about everyone in the state.  Looks like the increases will wipe out the benefit of the Federal stimulus plan and California taxpayers will end up with a wash!

Temporary – 2 Years

These additional taxes are temporary increases and will be in effect for a two-year period only, unless extended by a future budget deficit.

• Personal Income Tax – There is a 0.25% surcharge on the personal income tax, which will raise $3.658 billion.  If Federal stimulus funding is adequate, this increase could be reduced by up to one-half or 0.125%.  This increase will be for two years - 2009 and 2010 – and will impact higher-income taxpayers the most. 

• Vehicle License Fee - The fee would go up from the current level of 0.65% to 1% of the value of the vehicle.  An additional, ongoing, 0.15% will be tacked on - for a total of 1.15% - dedicated to local law enforcement programs.  The 0.15% for law enforcement is not temporary; thus, for two years, the license fee will be increased to 1.15% (1.00 .15).  After two years, the fee drops to 0.80% (0.65 .15), raising $1.476 billion (and $601.9 million for law enforcement).  Since the license fee will be based on the value of the car, this increase will apparently impact higher-income taxpayers, who presumably purchase costlier vehicles, the most.  Effective for registrations beginning May 19, 2009.

• Sales Tax – The state sales tax will increase by 1%, effective April 1, 2009.  This raises $5.969 billion.

Observation – Car Sales
This seems to undercut the Federal government’s efforts to rescue the auto industry by adding cost to purchase and own a new vehicle.  This should only prolong the trend to buy used cars instead of new ones.  However, the good news, under the recently enacted federal stimulus legislation, is that most taxpayers will be able to deduct the sales tax paid to purchase a new vehicle in 2009 as an above-the-line deduction on their federal returns; California did not adopt this provision.

• Dependent Credit – The dependent exemption credit is reduced to match the personal exemption credit.  This saves the state government $1.44 billion.  The personal credit amount for 2009 will not be released by the state until the fall, so its impact on 2009 cannot be determined until that time.  However, for 2008, the personal exemption credit was $99, and the credit for a dependent was $309.  That will be a credit reduction of $210 per dependent.  The impact on low- and very high-income taxpayers will be minimal, since the credit is nonrefundable and phased out for higher-income taxpayers.  Lower-income taxpayers generally don’t use all the credit anyway and higher-income ones don’t receive any part of the credit when their AGI exceeds the top of the phase-out range.  Thus, this increase will impact the middle-income taxpayer the most.

Some Increases Could Be Substantially Longer

Although each of these revenue adjustments are for two years only, the passage of the budget stabilization account reform would lengthen the:
o Sales tax by one year;
o The surtax by two years; and
o The vehicle license fee by three years.

The table below illustrates how the increases will impact a family of four (two children) based on the 2008 amounts:



(1) Since the taxpayer’s tax is only $420 (357 63), they were not getting the full benefit of the larger dependent tax credit. Their credit based on 2008 rates will be $396 (4 x 99).  Since their tax liability after subtracting the $396 credit from the $420 tax is only $24, they actually only lose $24 of that tax benefit.   

(2) The exemption credits are reduced $6 per exemption for every $2,500 of income over $326,379.  Thus, the $420 dependent tax credit would have been already phased out for taxpayers of this income so they don’t really lose any benefit.  

New for 2008 and 2009, taxpayers who do not itemize can add to their standard deduction the cost of their real property taxes, not to exceed $500 ($1,000 for joint filing taxpayers). 

Those who stand to benefit from this provision are taxpayers who pay property taxes but whose itemized deductions are less than the standard deduction.  This most frequently will include retired taxpayers who have paid off their home loans and do not have any mortgage interest to deduct.  Note that to the extent any real estate taxes are related to business property, such as a home office, and deducted elsewhere on the tax return, they cannot be included in the added standard deduction.

Take, for example, a retired married couple, both over age 65, who paid $2,500 in property taxes and have no other significant itemized deductions.  Prior to this law change, their 2009 standard deduction would have been $13,000 (the $11,400 basic amount for joint filers plus $2,200 as an additional amount for married couples both over 65).  With the added real property tax deduction, the couple’s standard deduction is increased by the lesser of their property taxes or $1,000.  Therefore, for 2009 their standard deduction will be $14,600.  Assuming that they are in the 15% tax bracket, this will save them $150 of federal income tax.

In actual application, some taxpayers who are marginally itemizing their deductions may find it beneficial to take the standard deduction for 2008.   Please call this office if you have any questions.

With the advent of the home sale gain exclusion back in the 1990s, taxpayers have been using that provision of the law in a popular strategy to exclude gain not just from their primary residence but also from rentals and second homes as well.  

They do that by moving into and making the rental or second home their primary residence for two years, then selling it and excluding the gain, up to $250,000 ($500,000 for joint filers). 

To qualify for the exclusion each taxpayer must own and occupy the home as their primary residence for two of the five years prior to the sale and have not utilized the exclusion in the two years immediately preceding the sale.   Thus, with careful planning taxpayers could employ this technique on multiple properties.

Apparently this strategy became too popular and Congress included a provision in the recently enacted Housing Assistance Act of 2008 to curtail gain exclusion attributable to periods of ownership when the property was not the taxpayer’s primary residence.  The new law accomplishes this by prorating the home sale gain between qualified and nonqualifed use periods and allowing the home gain exclusion to apply only to gain from qualified periods.

Example: An individual taxpayer purchases a home on 1/1/09 and rents it.  Then on 1/1/11 he occupies the property as his primary residence and two years later on 1/1/13 he sells the home for a $200,000 gain.  Prior to this law change, the entire $200,000 could have been excluded. However, under the new law taking effect after 2008, the taxpayer would have to apportion the gain between the periods when it was a rental and when it was a personal residence.  In this example he owned it four years, of which time use for two years was nonqualified, so 50% of the gain ($100,000) would be attributable to a nonqualified use period and would not be excludable.  As a result the taxpayer would be able to exclude only $100,000 of the $200,000 gain.  Note that had the taxpayer used the home as a second home instead of a rental the results would have been the same.

The law does provide a pretty liberal definition of nonqualified use.  A period of nonqualified use means any period during which the property is not used by the taxpayer or the taxpayer's spouse or former spouse as a principal residence except as noted below.  For purposes of determining periods of nonqualified use do not include any period:

o Before January 1, 2009

o After the last date the property is used as the principal residence of the taxpayer or spouse (regardless of use during that period), and

o Not to exceed two years that the taxpayer is temporarily absent by reason of a change in place of employment, health, or, to the extent provided in regulations, unforeseen circumstances.

If your planning strategies include employing multiple sales, each qualifying for the home sale exclusion, you should carefully analyze the impact of this new law on your plans.  Please call this office if you have any questions.

To stimulate home sales, Congress first established the first-time homebuyer credit in 2008, then modified it for 2009 (through November 30, 2009), and then extended it again through the middle of 2010 (2011 for certain service members) resulting in some complicated rules.

There are basically two credits, with significantly different sets of rules for each.  In addition, the extension legislation passed in November of 2009 added a new category of home buyer referred to as “long-time residents” and special provisions for U.S. Service Members.  The following is only an overview of these credits and you are encouraged to call this office in advance of a purchase to insure you will qualify for the credit.

2009 -2010 CREDIT HIGHLIGHTS:

• Credit Amount – The credit amount is based upon whether the buyer is a “first-time homebuyer” or a “long-time resident.”  See definition for both below.  The credit is 10% of the purchase price with a maximum credit of $8,000 ($4,000 for those filing married separate) for “first-time homebuyers” or $6,500 ($3,250 if married filing separate) for “long-time residents.” 

• Repayment Required: If the home is sold or ceases to be the taxpayer’s principal residence within 36 months of its purchase

• Purchased: Between January 1, 2009 and before May 1, 2010 (July 1, 2010 if the taxpayer had entered into a binding contract before May 1, 2010.  Note: Credit provisions are extended for one additional year for members of the uniformed services, U.S. Foreign Service, or an employee of the intelligence community (and, if married, the individual's spouse) who serves on qualified official extended duty service outside of the U.S. for at least 90 days during the period beginning after Dec. 31, 2008, and ending before May 1, 2010.

• Home Location: Within the U.S.

• Home Price: For homes purchased after November 6, 2009, no credit is allowed if the home’s purchase price exceeds $800,000.

• Seller: Cannot be purchased from a close relative.

• When Claimed: Credit can be claimed on the taxpayer’s return for the year of purchase or the preceding year

• Financing: Credit can be claimed even if financing is from tax-exempt mortgage revenue bonds

2008 CREDIT HIGHLIGHTS:

• Credit Amount: 10% of the purchase price with a maximum credit of $7,500 ($3,750 for those filing married separate)

• Repayment Required: In 15 equal annual installments beginning in 2010
• Purchased: After April 8, 2008 and before January 1, 2009

• Home Location: Within the U.S

• Seller: Cannot be purchased from a close relative

• When Claimed: Credit can be claimed on the taxpayer’s 2008 return

• Financing: No credit is allowed if the financing for the home is from tax-exempt mortgage revenue bonds.

Details: The following are some additional details that relate to the credit for both 2008 and 2009:

Definition of a First-Time Homebuyer - A taxpayer is considered a first-time homebuyer if he (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the three-year period before the purchase of the home to which the credit applies. If the individual is married, neither the individual nor his spouse may have had a present ownership interest in a principal residence during that three-year period, even if they file as married taxpayers filing separately. Ownership of a home outside the U.S. during the three-year period will not disqualify the taxpayer.

Definition of a Long-Time Resident - Any individual (and spouse, if married, i.e., both must meet qualifications) who have owned the same principal residence for any 5 consecutive years during the 8-year period ending on the date of purchase of a subsequent principal residence.

Coordination with D.C. First-Time Homebuyer Credit – No District of Columbia First-Time Homebuyer Credit is allowed to a taxpayer in 2009 or 2010 who also qualifies for the national first time homebuyer credit (which gives the taxpayer a greater credit).  If a taxpayer was eligible to claim the D.C. first-time homebuyer credit in 2008, or any prior year, the taxpayer was not eligible to claim the national first-time homebuyer credit for 2008.

Service Members Special Extension and Recapture Waiver - Credit provisions are extended for one additional year for members of the uniformed services, U.S. Foreign Service, or an employee of the intelligence community (and, if married, the individual's spouse) who serves on qualified official extended duty service outside of the U.S. for at least 90 days during the period beginning after Dec. 31, 2008, and ending before May 1, 2010:

• Qualifying Period Extension - Extends the credit provisions one year, through April 30, 2011 (June 30, 2011, in the case of an individual who enters into a written binding contract before May 1, 2010, to close on the purchase of a principal residence before July 1, 2011) for any of the following on qualified official extended duty.

• Recapture Waiver – In the case of a disposition of a principal residence by an individual (or a cessation of use of the residence that otherwise would cause recapture) after Dec. 31, 2008, in connection with Government orders received by the individual (or the individual's spouse) for qualified official extended duty service, no recapture applies by reason of the disposition of the residence, and any 15-year recapture with respect to a home acquired before Jan. 1, 2009, ceases to apply in the tax year of the disposition.

Homes That Qualify - Only the purchase of a main home located in the United States qualifies.  Vacation homes and rental property are not eligible.

Income Limits – The credit is reduced or eliminated for higher-income taxpayers.  The credit is phased out based on the modified adjusted gross income (MAGI).  MAGI is the adjusted gross income plus various amounts excluded from income - for example, certain foreign income.  The MAGI limits are different depending upon the purchase date of the home.

• For homes purchased before November 7, 2009 - The phase-out range is $150,000 to $170,000 for married taxpayers filing a joint return.  For other taxpayers, the phase-out range is $75,000 to $95,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less and for other taxpayers whose MAGI is $75,000 or less.

• For homes purchased after November 6, 2009 - The phase-out range is $225,000 to $245,000 for married taxpayers filing a joint return.  For other taxpayers, the phase-out range is $125,000 to $145,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $225,000 or less and for other taxpayers whose MAGI is $125,000 or less.

Who Cannot Take the Credit – In addition to the other qualifications and limitations discussed above, a taxpayer cannot take the credit if the following apply:

• Home is purchased from a close relative. This includes a spouse, parent, grandparent, child or grandchild.

• Home is no longer used as the main home.

• Home is sold before the end of the year in which it was purchased.

• If taxpayer is under the age of 18 (if married, both under the age of 18) on the date of purchase and the home is purchased after November 6, 2009.

• If the taxpayer can be claimed as a dependent of another.

• Taxpayer is a nonresident alien.

• Home financing comes from tax-exempt mortgage revenue bonds.

How and When the 2008 Credit Must Be Repaid - The 2008 credit is similar to a 15-year, interest-free loan. Normally, it is repaid in 15 equal annual installments beginning with the second tax year after the year the credit is claimed.  The repayment amount is included as an additional tax on the taxpayer's income tax return for that year.  For example, if a $7,500 first-time homebuyer credit is properly claimed on the 2008 return, the taxpayer will begin paying it back on his or her 2010 tax return.  Normally, $500 will be due each year from 2010 to 2024.

A taxpayer may need to adjust his or her withholding or make quarterly estimated tax payments to ensure that they are not under-withheld.

However, some exceptions apply to the repayment rule. They include:

• Taxpayer’s Death - If a taxpayer dies, any remaining annual installments are not due.  If a joint return was filed and the taxpayer passes away, the surviving spouse would be required to repay his or her half of the remaining repayment amount.

• Ceases Being Main Home - If a taxpayer stops using a home as the main home, all remaining annual installments become due on the return for the year that happens.  This includes situations where the main home becomes a vacation home or is converted to business or rental property.  There are special rules for involuntary conversions. 

• Home Sold - If a home is sold, all remaining annual installments become due on the return for the year of sale.  The repayment is limited to the amount of gain on the sale, if the home is sold to an unrelated taxpayer.  If there is no gain or if there is a loss on the sale, the remaining annual installments may be reduced or even eliminated.  For example, a home is purchased for $200,000 and the credit of $7,500 is claimed.  Assume that no improvements are made on the home and it is sold for $195,000 after repaying $500 of the credit.  The gain or loss would be measured for purposes of the accelerated credit recapture from $193,000 (the original cost of $200,000 less the $7,500 credit plus the $500 repayment).  In this case, there would be a gain of $2,000 on the sale ($195,000 - $193,000).   Thus, the taxpayer would only be liable for repaying $2,000 of the credit when the home is sold.  Had the home sold for $193,000 or less, there would be no repayment required.

• Divorce - If a home is transferred to a spouse or to a former spouse (as part of a divorce settlement), that person is responsible for making all subsequent installment payments.

• Involuntary Conversion - If the home is involuntarily converted (e.g., it is destroyed in a storm), and the taxpayer buys a new principal residence within a two-year period beginning on the date of the disposition or the date the home ceases to be the principal residence, the accelerated recapture rule does not apply.  However, the regular recapture rule applies to the replacement principal residence during the recapture period in the same way as if the replacement principal residence were the converted residence.

If you or a family member is contemplating on utilizing this credit, it may be appropriate to consult with this office in advance of a home purchase. 

Your tax will be the higher of the tax computed the regular way or the Alternative Minimum Tax. Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. In addition to those items listed above, watch out for transactions involving limited partnerships, depreciation and business tax credits only allowed against the regular tax. All of these can strongly impact your bottom line tax and raise a question of possible AMT. Tax Tip: If you were subject to the AMT in the prior year and had a state tax refund in that year, part or all of your state income tax refund from that year may not be includable in the regular tax computation. To the extent you received no tax benefit from the state tax deduction because of the AMT, that portion of the refund is not includable in the subsequent year’s income.

Congress has procrastinated for several years on AMT reform.  Each year, they temporarily increase the exemption amount for inflation, leaving taxpayers in doubt about the future years.  Without these annual patches, the IRS estimates that an additional 14% of the nation’s taxpayers will be affected by the AMT and hit with an unexpected tax increase.  For 2009, Congress again patched the AMT with increased exemption amounts as shown in the table below.  We will have to wait and see what happens for 2010.

AMT EXEMPTION PHASE OUT

Filing Status	Exemption Amount	Income Where Exemption Is Totally Phased Out
Married Filing Jointly	$70,950	$330,000
Married Filing Separate	$35,475	$165,000
Unmarried	$46,700	$247,500

AMT TAX RATES

AMT Taxable Income 0 – 175,000(1) Over 175,000(1)

Tax Rate 26% 28%

Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. In addition to those items listed above, watch for transactions involving incentive stock options, limited partnerships, and tax-free income from private activity bonds, depreciation, and tax credits. All of these can strongly impact your bottom line tax and raise a question of possible AMT.

Every year, many of the various tax limitations, deductions, allowances, etc., are inflation adjusted. The following are the more commonly-encountered values that apply to 2009, along with the prior year's amounts. Click here for the table.

These are not the only items that are inflation adjusted. If you have questions regarding other limitations not listed here, please call this office.

A new law passed late in 2008 allows taxpayers age 70-½ and over and those who have inherited IRAs (beneficiaries) to forego their required minimum distribution (RMD) from 401(k) plans, IRAs, and similar retirement arrangements for 2009.  Thus, these individuals can take a distribution less than required, even none, and avoid the 50% RMD penalty. Keep in mind that this is for tax year 2009 only.  So if you turned 70-½ in 2008 and delayed the first distribution from your IRA to 2009, as permitted in the first RMD year, you will still be required to make that delayed distribution in 2009 and no later than April 1, 2009. On the other hand, if you turn 70-½ in 2009, your first distribution would normally be required by April 1, 2010, but due to the new law’s suspension provision, a distribution for 2009 is not required. However, you will be required to take your 2010 RMD by December 31, 2010.

Background: The reason for the RMD is to ensure that taxpayers take at least some taxable distributions from their retirement accounts over their lifetimes.  These distributions are based on the taxpayer’s age, and the percentage of the retirement account that must be distributed each succeeding year increases based upon annuity tables.  Each year’s distribution is based on the value of the retirement account on December 31 of the prior year.  

Problem: Most individuals have some, if not all, of their retirement funds invested in stocks or mutual funds. The decline in the stock market coupled with the requirement that the current year’s distribution be based on the prior year’s year-end value creates an unfavorable situation for withdrawals.  Because of the way in which RMDs are calculated (i.e., based on the previous year's closing value), the law would have forced those individuals taking distributions in 2009 to receive a disproportionately large portion of their remaining account balance.  And, to generate the cash required for the distributions, they would have been forced to sell stock or mutual fund shares at exceptionally depressed values.  Therefore, this new law gives the taxpayer the opportunity to forego a distribution without penalty for 2009.

What You Should Do:  Whether you should take a distribution, a reduced distribution, or no distribution at all for 2009 should be based on your unique financial and tax circumstances. Although this list by no means includes everything, here are some things to consider:

• If your taxable income for 2009 is low, you may wish to take a distribution anyway to take advantage of a zero or low tax rate.

• If you need to take a distribution to cover living expenses, you may still be able to minimize the distribution.

• If you are receiving Social Security and need to supplement your Social Security income with a distribution, keep in mind that the tax on the Social Security income is based on your total income, and by minimizing your distribution you might also reduce the tax on the Social Security income.

• If you can support your yearly living expenses with other funds, you can forego a distribution altogether for 2009.

• If your income is abnormally high for 2009 and you expect it to be lower in 2010, you might want to delay any distributions until 2010.

The foregoing is a summarization of the special rule for 2009. If you have questions or wish to optimize your 2009 distribution to suit your circumstances, please call.

The provision that permits taxpayers age 70½ and over to make direct distributions (up to $100,000) from their IRA account to a charity has been reinstated for 2008 and 2009.  The distribution is tax-free, but there is no charitable deduction.  This provision can be very beneficial to taxpayers who have social security income and/or do not itemize their deductions.

IMPORTANT! If you are over 70½, you must act quickly to take advantage of this provision for 2008.  This provision can substantially benefit low-income taxpayers, as well as the more wealthy individuals.  Please call if you are contemplating a cash charitable contribution between now and the end of the year to see if it would benefit you to make a direct contribution from your IRA.

The key benefits of this provision lie in the fact that the distribution;

(1) Is not included in the taxpayer’s income for the year,

(2) Counts toward the taxpayer’s minimum required distribution for the year, and

(3) Does count as a charitable contribution for the year.  This is of no importance for 2009 distributions since they are suspended for 2009. However, it would count as the RMD for taxpayers who turned 70½ in 2008 and delayed their RMD until 2009.

How does a taxpayer benefit from this provision?

• By making a contribution directly from the IRA, taxpayers are able to exclude the amount that was contributed from their income for the year, which is essentially the same as deducting the contribution without itemizing their deductions.

• This technique also lowers a taxpayer’s adjusted gross income (AGI) for other tax breaks pegged at various AGI levels, such as medical expenses, passive losses, etc., allowing them greater benefits from the AGI limited deductions.

• For taxpayers receiving Social Security (SS), the taxability of the SS is also based on income.  Thus, excluding the portion of the IRA distribution directly distributed to the charity can reduce the taxable portion of the SS.

• Taxpayers who wish to make very large contributions (up to the 100,000 limit) can do so with IRA funds that would have otherwise been taxable to them.

Example: Retired couple (both over 70½) file a joint return.  Their income consists primarily of RMD from their IRA accounts totaling $35,500, both of their SS incomes totaling $28,000, and $2,000 of investment income.  They are very active with their church and make a $14,000 contribution each year. They have no other income or deductions.  Compare the 2006 results with and without a qualified charitable distribution:

 

In this example, instead of making a charitable contribution, the taxpayer made a qualified charitable distribution of $14,000, lowering their AGI, reducing their taxable SS, and then using the standard deduction.  Result: Tax savings of $2,936. 

Caution – It is important to stress that a qualified charitable IRA contribution must be directly distributed to the qualified charity. Otherwise, the distribution is taxable as income and the charitable deduction would be taken on the taxpayer’s itemized deductions subject to all the normal limitations.  Please call this office before attempting to execute this strategy.

The Economic Stability Legislation that was passed into law on October 3, 2008 included several individual bills that Congress had before them.  One of the bills was the 2008 Extenders Act that reinstated and extended several popular tax benefits.  Among those items were the following three popular deductions, which have been reinstated and extended for 2009.

• Deduction for State and Local Sales Taxes – With this provision, a taxpayer may elect to claim an itemized deduction for state and local general sales taxes instead of  deducting state and local income taxes.  It primarily benefits taxpayers in states with no income tax.  However, this deduction can also be beneficial to taxpayers whose sales tax deduction exceeds their state and local income tax deduction.  The sales tax deduction can be based on actual receipts OR the amount from the IRS income-based table PLUS sales tax paid when purchasing motor vehicles, boats, aircrafts, homes (including mobile and prefabricated homes), and materials to build a home.  When using the IRS income-based tables, the income is based upon spendable income which includes income that is not included in the adjusted gross income such as; worker’s compensation, public assistance payments, tax exempt military compensation tax-exempt interest, nontaxable portions of Social Security, railroad, or veterans retirement benefits, etc.

• Deduction of Qualified Tuition & Related Expenses - This above-the-line deduction (can be claimed without itemizing) allows a taxpayer to claim a deduction for qualified tuition and related expenses for higher (post-secondary) education.  The maximum deduction is $4,000 for an individual whose adjusted gross income (AGI) for the tax year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other individuals whose AGI does not exceed $80,000 ($160,000 in the case of a joint return).  No deduction is allowed for an individual whose AGI exceeds the relevant AGI limits, for a married individual who does not file a joint return, or for an individual whose personal exemption deduction may be claimed by another taxpayer for the tax year.

• Educator Above-the-Line Expenses - The above-the-line deduction for educators (kindergarten through 12th grade) permits eligible educators to claim an above-the-line deduction for up to $250 annually for expenses paid or incurred for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used by the eligible educator in the classroom.  To be eligible for this deduction, the expenses must be otherwise deductible as a trade or business expense.  Generally, an eligible educator includes a teacher, instructor, counselor, principal, or aide who works in a school for at least 900 hours during a school year.

• Additional Standard Deduction for State and Local Property Taxes – Although this deduction is new for 2008, it was also extended through 2009.  This tax provision allows taxpayers who claim the standard deduction, instead of itemizing deductions, to claim an additional standard deduction for state and local property taxes paid.  The deduction cannot exceed the lesser of state and local property taxes actually paid or $500 ($1,000 for joint return filers).  No taxes deductible in computing adjusted gross income are taken into account in computing the increased standard deduction.  Taxpayers who marginally itemize their deductions may find it more beneficial to use the standard deduction with the added standard for property taxes.

If you have questions related to these deductions, please give this office a call.

Over the past several months, Congress has been enacting legislation to stabilize the economy.  At the urging of the incoming administration, Congress is working on yet another stimulus plan.  As they make temporary changes to the tax code and extend expiring provisions, and with the phase-in phase-out provisions of earlier legislation, it becomes more difficult to keep track of what does and does not apply for the 2009 year.  The following are highlights of the provisions affecting small to medium-sized businesses for 2009:

• The FUTA (Federal Unemployment Tax Act) tax rate had been scheduled to drop to 6% after 2008, but under the new law, it will remain at 6.2% through 2009 and will drop to 6% for 2010 and later.

• Section 179 Expense Deduction – This deduction dropped substantially for 2009.  The maximum Sec. 179 deduction for 2009 is $133,000 ($66,500 if married filing separately).  This is down from the $250,000 allowance in 2008.  For 2009, if more than $530,000 is invested in Sec. 179 property, the maximum deduction is reduced. It is quite likely that the incoming Congress will revise this deduction again in its stimulus plan.  

• 50% Bonus Depreciation – The special 50% first-year bonus depreciation for equipment purchased during the year was NOT extended past 2008.  This is another area where the new Congress might make a change for 2009.

• Food & Book Inventory Contributions - A two-year extension through 2009 of enhanced charitable contribution deduction rules for gifts of certain types of food inventory, and corporate gifts of book inventory or computer equipment to schools was enacted.

• Environmental Remediation Expenses - The tax break that allows expensing of qualified environmental remediation expenses, namely cleanup of hazardous substances (including petroleum products) at qualified contaminated sites, was extended two years, through 2009.

• Energy-Efficient Commercial Building - The deduction for energy-efficient commercial building property has been extended so that it applies through 2013.

• Electric Drive Motor Vehicles - For purchases after 2008 and before 2015, taxpayers will be able to claim a tax credit for electric drive motor vehicles.

• Bicycle Commuting Fringe Benefit - After 2008, companies will be able to give employees who commute by bicycle a $20 per month tax-free reimbursement for reasonable bicycle-related expenses.

• Disaster Area Clean Up - Through 2010, qualified disaster expenses, such as clean up (removal of debris, demolition of structures) and repairs, may be expensed.

• Disaster Loss Carryback - A 5-year net operating loss (NOL) carryback applies for losses resulting from a casualty within a disaster area instead of the usual 2- or 3-year carryback periods available for other types of business losses. This provision is valid through 2010.

• Section 179 Expense Increased in Disaster Areas – Through 2010, the otherwise maximum amount of machinery and equipment that may be expensed under Section 179 is increased by up to $100,000 for qualifying assets, and the investment-based phase-out of the expensing deduction is increased by $600,000.

• Through 2010 - A 50% first-year bonus depreciation allowance applies to most types of machinery and equipment bought to rehabilitate or replace damaged property.  A number of conditions must be met, and certain types of property are excluded (including property eligible for the more widely applicable 50% first-year bonus depreciation allowance enacted as part of the Economic Stimulus Act of 2008).

• Farming – There is a 5-year quick depreciation write-off for most farm machinery and equipment placed in service after 2008 and before 2010.

• Real Estate, Retailers and Restaurants - The 15-year depreciation write-off for qualifying leasehold improvements and qualifying restaurant property has been extended through 2009.  What's more, for property placed in service after 2008 and before 2010, (a) buildings as well as building improvements may qualify for the quick write-off for restaurant property; and (b) the 15–year depreciation write-off also applies to qualifying retail improvement property.

• Construction Companies - The $2,000 tax credit for building energy-efficient homes ($1,000 for manufactured homes) has been extended to apply to homes acquired through 2009.  Note that construction companies also may benefit indirectly from the extended and enhanced tax breaks for real estate, restaurants and retailers.

• Reuse & Recycling Equipment - For property placed in service after August 31, 2008, the new law permits 50% first-year bonus depreciation for qualified reuse and recycling property.  In general, this is machinery and equipment (not including buildings or real estate), along with associated property, including software necessary to operate the equipment, which is used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials.  This break is not limited to businesses in the recycling industry.

• Film and TV - The option to expense up to $15 million of qualifying film and TV productions ($20 million if produced in certain low-income areas) is extended so that it applies for productions beginning before 2010; also, the qualified domestic production activities deduction has been liberalized in several ways for this industry, effective for tax years beginning after 2007.

• Motorsports Racing - The short 7-year write-off for land improvements and support facilities at motorsports entertainment complexes has been extended to apply for property placed in service before 2010.

• Oil and Gas —There are three significant changes:

(1) The otherwise available domestic production activities deduction for companies that have oil-related income will be reduced after 2009 (a complex reduction formula will apply);

(2) The rule providing that percentage depletion from marginal oil and gas wells isn't limited to 100% of income from these properties is extended though 2009; and

(3) The rules relating to foreign tax credits for the oil and gas industry have been revised for tax years beginning after 2008.

Please keep in mind that the foregoing are only highlights of changes affecting businesses in 2009.  If you would like more details, please call at your convenience.

If the decline in the real estate market or the nation’s economic downturn has caused you to lose your home by foreclosure or short sale, or you voluntarily signed the deed over to the lienholder, you will probably be faced with debt relief income. You can also have debt relief income if you had a credit card, an automobile loan, or other debt forgiven in a settlement with a credit card company or other lender. 
 
Normally, debt forgiveness results in taxable income.  But there are several provisions of the tax code that allow individuals to exclude debt relief income and thereby avoid taxes on the forgiven income.  The two exclusions that will most often apply this year are:

• Insolvent Taxpayer Exclusion — An insolvent taxpayer is one whose debts (liabilities) exceed his assets.  Tax law generally allows taxpayers to exclude debt relief income to the extent their liabilities exceed their assets.  In addition, when adding up the assets, a taxpayer does not need to include assets excluded under state bankruptcy law.  Although the concept is rather simple, inventorying and appraising assets and liabilities can be a tedious and time-consuming job.  Yet, it should be accomplished as soon as possible since valuations are based upon the assets’ values and the amount of the liabilities immediately before the debt is relieved.

• Home Mortgage Debt Relief — Under a special rule that applies to years 2007 through 2012, taxpayers can exclude from taxation up to $2 million ($1 million for an unmarried person filing separately) of home “acquisition” debt forgiven on their principal residence.  Debt forgiven on second homes, rental property, business property, credit cards, or car loans do not qualify for this special tax-relief provision. 

Whenever your debt is reduced or eliminated, you will receive a year-end statement (Form 1099-C) from your lender.  By law, this form must show the amount of debt forgiven, and if the debt relief involves a foreclosure or repossession, Form 1099-C will generally include the fair market value of the property taken back by the lender.

The information included on the 1099-C is not always correct, and it may be necessary to notify the lender immediately if any of the information shown is in error.  

If you have had debt or mortgage relief during the year, you are encouraged to contact this office right away, while more time is available, so we can determine the impact on your tax liability and explore any mitigating options before the year ends.  

The Internal Revenue Service has acknowledged the certifications by manufacturers that certain advanced lean-burn technology vehicles qualify for the alternative motor vehicle tax credit.

Before, only hybrid vehicles, fuel cell vehicles and alternative fuel vehicles had been certified, but now certain advanced lean-burn technology vehicles, which generally run on diesel fuel have been certified.  These vehicles are passenger cars or light trucks with an internal combustion engine designed to operate primarily using more air than is necessary for complete combustion of the fuel.  The vehicles also must incorporate direct fuel injection technology and achieve at least 125 percent of the 2002 model year city fuel economy rating.

Available credit amounts may vary and include a base credit amount based on fuel economy compared to the 2002 model year city fuel economy rating and an additional amount based on the vehicle’s lifetime fuel savings.  For a taxpayer to claim the credit, the original use of the vehicle must begin with the taxpayer, and the vehicle must be acquired for use or lease by the taxpayer and not for resale.

There is a limitation on the number of qualified hybrid and advanced lean-burn technology vehicles eligible for credit.  The phase-out period begins when a manufacturer sells 60,000 qualified hybrid and advanced lean-burn technology vehicles.

Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th hybrid passenger automobile or light truck or advanced lean-burn technology motor vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit.  For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit.  No credit is allowed after the fifth quarter.

Neither of the manufacturers listed below have reached the phase-our periods and full credit is still available. The qualifying vehicles and their credit amounts are:

• 2009 Volkswagen Jetta 2.0L TDI Sedan manual or automatic - $1,300
• 2009 Volkswagen Jetta 2.0L TDI SportWagen manual or automatic - $1,300
• Mercedes GL 320 Blue TEC - $1,800
• Mercedes R 320 Blue TEC - $1,550
• Mercedes ML 320 Blue TEC - $900

The “American Recovery and Reinvestment Act of 2009” (the 2009 Recovery Act) reinstated and expanded the residential energy improvement credit for 2009 and 2010 (this credit was last available in 2007) and extended and expanded the tax credit for residential solar and fuel cell equipment through 2016.  This gives taxpayers who want to “go green” a chance to offset some of the cost of going green with tax credits.  

Tax Credit for Residential Energy Improvements – Energy property improvements to a principal residence located in the United States and placed in service during 2009 and 2010 qualify for the residential energy improvement credit. The credit is 30% of the cost of:

o Qualified advanced main air circulating fan;
o Qualified natural gas, propane, or oil furnace;
o Qualified natural gas, propane, or oil hot water boiler;
o Qualified energy efficient heat pumps;
o Qualified energy efficient water heaters;
o Qualified energy efficient central air conditioners;
o Qualifying insulation;
o Qualified exterior windows including skylights;
o Qualified exterior doors;
o Qualified metal roofs coated with heat-reduction pigments; and
o Qualified asphalt roofing with appropriate cooling granules. 

This credit is limited to $1,500 for 2009 and 2010 (combined, not each year).  If you claimed pre-2008 credits under this provision, they are not counted toward the new $1,500 limit.  No credit is allowed for amounts paid or incurred for onsite preparation, assembly or original installation of the component.  The improvement’s original use must commence with the taxpayer, and the improvement must reasonably be expected to remain in use for at least five years. 
 
Residential Energy Efficient Property Credit (REEP Credit) – This credit is available for years 2009 through 2016.  The installation must be on the taxpayer’s main or second home located in the U.S.  A 30% credit with no maximums (except as noted) applies to the following items:

o Qualified solar water heaters 
o Residential solar electric systems    
o Fuel cell equipment – with a maximum credit of $500 for each half-kilowatt of capacity
o Qualified wind energy equipment
o Qualified geothermal energy equipment

Labor costs for onsite installation and for piping and wiring connections are qualifying costs for these credits.  However, the credits do not apply to equipment used to heat swimming pools or hot tubs. 

Definition of “Qualified” – These credits are only allowed for “energy efficient components” and the term “qualified” means the components must meet certain energy efficient standards.  That doesn’t mean you need to have an engineering degree to determine which components qualify.  For each qualified component the manufacturer is required to supply a certification that the components comply with the energy efficient standards.

The IRS has indicated that a taxpayer may rely on a manufacturer’s certification that the component is eligible for the credit, provided that the IRS hasn’t withdrawn the certification.  The taxpayer is not required to attach the certification statement to the return on which the credit is claimed but must retain it with the taxpayer’s records. Reliance on the certification is allowed only if installation of the component is consistent with the certification (for example, the item must be installed in the appropriate climate zone identified in the certificate statement).

Exception for exterior windows and skylights: An exterior window or skylight that bears an “Energy Star” label and is installed in the region identified on the label may be treated as an eligible component even without a manufacturer’s certification statement.

Credit Limitations – Although these credits can be used to offset both the regular tax and AMT, they are nonrefundable personal credits that can only reduce a taxpayer’s tax to zero, and any remaining balance is not refundable.  If the amount of the credit for the residential energy efficient property credit (REEP - i.e., the credit for residential solar and fuel cell equipment and wind/geothermal energy equipment) exceeds the taxpayer’s tax after subtracting other nonrefundable personal credits, the excess can be carried to the next tax year and is added to that year’s allowable credit.

Caution - You are strongly urged to contact this office before entering into any contractual arrangements to install any of these energy items to first verify what your tax benefit might be.

The extended due dates for returns of calendar-year trusts and estates (1041), partnerships (1065), and certain other returns that generate form K-1s have historically been the same as for individual returns (1040).  Since these returns generally include information that is required to complete the individual returns of beneficiaries or partners, having the same extended due dates does not always give the beneficiary or the partner the ability to timely meet their filing obligation.  This can lead to a variety of penalties on the individual 1040 returns. 

New IRS regulations designed to ease this problem have shortened the extended due date for 1041 and 1065 returns by one month.  Thus, beginning in 2009, the extension period for these returns has been reduced to five months (previously six months) while the extension period for individual 1040 returns remains at six months.  This provides the 1040 filer with one additional month to complete and file individual 1040 returns.

The change will be effective for extension requests for returns due on or after January 1, 2009 and applies to any business entity filing any of the following forms:

• Form 1065 (U.S. Return of Partnership Income);
• Form 1041 (U.S. Income Tax Return for Estates and Trusts);
• Form 8804 (Annual Return for Partnership Withholding Tax)

The IRS is eliminating the same-day deadline for these returns and 1040 returns, which causes needless hardship and puts the individual taxpayer in an awkward position.  Thus, under the new rule, a calendar-year partnership’s or trust’s extended return will be due on September 15, while the partner’s or beneficiary’s extended individual return will be due on October 15.

If you feel you are unable to have the information needed to file the income tax return of a trust, estate, or partnership return on time, please contact this office to arrange for filing of extensions for both the pass-through return and your individual return.  Please keep in mind the extension is an extension to file but not an extension to pay.  Thus, the late payment penalty and interest will apply to any balance due on the individual return that isn’t paid by the original due date.  Therefore, it is important to complete the returns as quickly as possible when on extension.

Beginning in 2010, the new legislation:

(1) Eliminates the $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs, and

(2) Permits married taxpayers filing a separate return to convert amounts in a traditional IRA into a Roth IRA. Under prior law, married taxpayers who filed separate returns were restricted from making conversions.

In addition, for conversions made in 2010, the taxpayer can choose to elect to:

a. Include the income in the 2010 return, or
b. Include one-half of the conversion income in 2011 and one-half in 2012.

Note: 2010 is the last year for the current “low” tax rates unless Congress extends them in future legislation. Thus, using the option to include the income in 2011 and 2012 may not be a good option for taxpayers that may be subject to the increased tax rates after 2010.

Planning Ahead for Roth 2010 Rollover Strategies - Looking ahead, there are some interesting strategies a taxpayer can employ to convert nondeductible traditional IRA contributions to a Roth IRA, thereby funding the more favorable Roth IRA.

• Strategy - Taxpayers who have employer plans and are restricted from making deductible traditional IRA contributions because of income level can make nondeductible traditional IRA contributions in the tax years leading up to 2010, and then convert those nondeductible traditional IRAs to Roth IRAs with virtually no tax since they were nondeductible. Only the earnings would be taxable. Taxpayers who are prohibited from making Roth IRA contributions because their income exceeds the limit may also benefit from this strategy.

• Strategy - Using the same strategy above, even a taxpayer who can make a deductible contribution can elect to make it nondeductible, providing the same result as above.

• Strategy – Generally, rollovers are thought of as transfers from a qualified plan to an IRA or from one IRA to another IRA. However, beginning in 2002, the law has allowed an IRA to be rolled (or transferred) to other qualified plans including 401(k) plans, 403(a) and 403(b) annuities and 457 governmental retirement plans (assuming the plan will accept the IRA funds). In addition, the law only allows the taxable portion of the IRA to be moved to qualified plans. For taxpayers who have mixed IRAs (including both deductible and nondeductible contributions), this provides a means to segregating the taxable and nontaxable amounts and then later converting the nontaxable portion without paying any conversion tax (except on any interim earnings). Thus, the taxable portion can be rolled into a qualified plan, leaving the nontaxable portion in the IRA where it can be converted to the Roth IRA.

• Strategy - More aggressive taxpayers with the financial resources to pay the rollover tax might also consider rolling (or transferring) the funds from a qualified plan into a traditional IRA and then converting the traditional IRA to a Roth IRA.

The amount of tax imposed on a Roth conversion will depend on a number of issues including the taxpayer’s marginal tax bracket, intended conversion amount and whether or not the conversion is made in one or multiple years. Also a factor is whether the taxpayer made deductible IRA contributions in earlier years in addition to the nondeductible contributions intended for rollover to the Roth. All of the taxpayer’s regular, SEP and SIMPLE IRAs have to be combined when determining the amount that is taxable upon conversion, so there could be unintended taxable consequences. Minimizing the conversion tax requires careful planning and strict adherence to the conversion rules.

To stimulate home sales, Congress first established the first-time homebuyer credit in 2008, then modified it for 2009 (through November 30, 2009), and then extended it again through the middle of 2010 (2011 for certain service members) resulting in some complicated rules.

There are basically two credits, with significantly different sets of rules for each.  In addition, the extension legislation passed in November of 2009 added a new category of home buyer referred to as “long-time residents” and special provisions for U.S. Service Members.  The following is only an overview of these credits and you are encouraged to call this office in advance of a purchase to insure you will qualify for the credit.

2009 -2010 CREDIT HIGHLIGHTS:

• Credit Amount – The credit amount is based upon whether the buyer is a “first-time homebuyer” or a “long-time resident.”  See definition for both below.  The credit is 10% of the purchase price with a maximum credit of $8,000 ($4,000 for those filing married separate) for “first-time homebuyers” or $6,500 ($3,250 if married filing separate) for “long-time residents.” 

• Repayment Required: If the home is sold or ceases to be the taxpayer’s principal residence within 36 months of its purchase

• Purchased: Between January 1, 2009 and before May 1, 2010 (July 1, 2010 if the taxpayer had entered into a binding contract before May 1, 2010.  Note: Credit provisions are extended for one additional year for members of the uniformed services, U.S. Foreign Service, or an employee of the intelligence community (and, if married, the individual's spouse) who serves on qualified official extended duty service outside of the U.S. for at least 90 days during the period beginning after Dec. 31, 2008, and ending before May 1, 2010.

• Home Location: Within the U.S.

• Home Price: For homes purchased after November 6, 2009, no credit is allowed if the home’s purchase price exceeds $800,000.

• Seller: Cannot be purchased from a close relative.

• When Claimed: Credit can be claimed on the taxpayer’s return for the year of purchase or the preceding year

• Financing: Credit can be claimed even if financing is from tax-exempt mortgage revenue bonds

2008 CREDIT HIGHLIGHTS:

• Credit Amount: 10% of the purchase price with a maximum credit of $7,500 ($3,750 for those filing married separate)

• Repayment Required: In 15 equal annual installments beginning in 2010
• Purchased: After April 8, 2008 and before January 1, 2009

• Home Location: Within the U.S

• Seller: Cannot be purchased from a close relative

• When Claimed: Credit can be claimed on the taxpayer’s 2008 return

• Financing: No credit is allowed if the financing for the home is from tax-exempt mortgage revenue bonds.

Details: The following are some additional details that relate to the credit for both 2008 and 2009:

Definition of a First-Time Homebuyer - A taxpayer is considered a first-time homebuyer if he (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the three-year period before the purchase of the home to which the credit applies. If the individual is married, neither the individual nor his spouse may have had a present ownership interest in a principal residence during that three-year period, even if they file as married taxpayers filing separately. Ownership of a home outside the U.S. during the three-year period will not disqualify the taxpayer.

Definition of a Long-Time Resident - Any individual (and spouse, if married, i.e., both must meet qualifications) who have owned the same principal residence for any 5 consecutive years during the 8-year period ending on the date of purchase of a subsequent principal residence.

Coordination with D.C. First-Time Homebuyer Credit – No District of Columbia First-Time Homebuyer Credit is allowed to a taxpayer in 2009 or 2010 who also qualifies for the national first time homebuyer credit (which gives the taxpayer a greater credit).  If a taxpayer was eligible to claim the D.C. first-time homebuyer credit in 2008, or any prior year, the taxpayer was not eligible to claim the national first-time homebuyer credit for 2008.

Service Members Special Extension and Recapture Waiver - Credit provisions are extended for one additional year for members of the uniformed services, U.S. Foreign Service, or an employee of the intelligence community (and, if married, the individual's spouse) who serves on qualified official extended duty service outside of the U.S. for at least 90 days during the period beginning after Dec. 31, 2008, and ending before May 1, 2010:

• Qualifying Period Extension - Extends the credit provisions one year, through April 30, 2011 (June 30, 2011, in the case of an individual who enters into a written binding contract before May 1, 2010, to close on the purchase of a principal residence before July 1, 2011) for any of the following on qualified official extended duty.

• Recapture Waiver – In the case of a disposition of a principal residence by an individual (or a cessation of use of the residence that otherwise would cause recapture) after Dec. 31, 2008, in connection with Government orders received by the individual (or the individual's spouse) for qualified official extended duty service, no recapture applies by reason of the disposition of the residence, and any 15-year recapture with respect to a home acquired before Jan. 1, 2009, ceases to apply in the tax year of the disposition.

Homes That Qualify - Only the purchase of a main home located in the United States qualifies.  Vacation homes and rental property are not eligible.

Income Limits – The credit is reduced or eliminated for higher-income taxpayers.  The credit is phased out based on the modified adjusted gross income (MAGI).  MAGI is the adjusted gross income plus various amounts excluded from income - for example, certain foreign income.  The MAGI limits are different depending upon the purchase date of the home.

• For homes purchased before November 7, 2009 - The phase-out range is $150,000 to $170,000 for married taxpayers filing a joint return.  For other taxpayers, the phase-out range is $75,000 to $95,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less and for other taxpayers whose MAGI is $75,000 or less.

• For homes purchased after November 6, 2009 - The phase-out range is $225,000 to $245,000 for married taxpayers filing a joint return.  For other taxpayers, the phase-out range is $125,000 to $145,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $225,000 or less and for other taxpayers whose MAGI is $125,000 or less.

Who Cannot Take the Credit – In addition to the other qualifications and limitations discussed above, a taxpayer cannot take the credit if the following apply:

• Home is purchased from a close relative. This includes a spouse, parent, grandparent, child or grandchild.

• Home is no longer used as the main home.

• Home is sold before the end of the year in which it was purchased.

• If taxpayer is under the age of 18 (if married, both under the age of 18) on the date of purchase and the home is purchased after November 6, 2009.

• If the taxpayer can be claimed as a dependent of another.

• Taxpayer is a nonresident alien.

• Home financing comes from tax-exempt mortgage revenue bonds.

How and When the 2008 Credit Must Be Repaid - The 2008 credit is similar to a 15-year, interest-free loan. Normally, it is repaid in 15 equal annual installments beginning with the second tax year after the year the credit is claimed.  The repayment amount is included as an additional tax on the taxpayer's income tax return for that year.  For example, if a $7,500 first-time homebuyer credit is properly claimed on the 2008 return, the taxpayer will begin paying it back on his or her 2010 tax return.  Normally, $500 will be due each year from 2010 to 2024.

A taxpayer may need to adjust his or her withholding or make quarterly estimated tax payments to ensure that they are not under-withheld.

However, some exceptions apply to the repayment rule. They include:

• Taxpayer’s Death - If a taxpayer dies, any remaining annual installments are not due.  If a joint return was filed and the taxpayer passes away, the surviving spouse would be required to repay his or her half of the remaining repayment amount.

• Ceases Being Main Home - If a taxpayer stops using a home as the main home, all remaining annual installments become due on the return for the year that happens.  This includes situations where the main home becomes a vacation home or is converted to business or rental property.  There are special rules for involuntary conversions. 

• Home Sold - If a home is sold, all remaining annual installments become due on the return for the year of sale.  The repayment is limited to the amount of gain on the sale, if the home is sold to an unrelated taxpayer.  If there is no gain or if there is a loss on the sale, the remaining annual installments may be reduced or even eliminated.  For example, a home is purchased for $200,000 and the credit of $7,500 is claimed.  Assume that no improvements are made on the home and it is sold for $195,000 after repaying $500 of the credit.  The gain or loss would be measured for purposes of the accelerated credit recapture from $193,000 (the original cost of $200,000 less the $7,500 credit plus the $500 repayment).  In this case, there would be a gain of $2,000 on the sale ($195,000 - $193,000).   Thus, the taxpayer would only be liable for repaying $2,000 of the credit when the home is sold.  Had the home sold for $193,000 or less, there would be no repayment required.

• Divorce - If a home is transferred to a spouse or to a former spouse (as part of a divorce settlement), that person is responsible for making all subsequent installment payments.

• Involuntary Conversion - If the home is involuntarily converted (e.g., it is destroyed in a storm), and the taxpayer buys a new principal residence within a two-year period beginning on the date of the disposition or the date the home ceases to be the principal residence, the accelerated recapture rule does not apply.  However, the regular recapture rule applies to the replacement principal residence during the recapture period in the same way as if the replacement principal residence were the converted residence.

If you or a family member is contemplating on utilizing this credit, it may be appropriate to consult with this office in advance of a home purchase. 

The Hope education credit, which provides a tax credit up to $1,800 for qualified higher education, has been enhanced and renamed for 2009 and 2010.  For these two years, it will be called the American Opportunity tax credit.  Where the Hope credit only applied to the first two years of post-secondary education, the American Opportunity credit will be available for four years of college, and the maximum credit per student increases to $2,500.  The credit will be based on 100% of the first $2,000, and 25% of the next $2,000, of tuition, fees and course material (including books) expenses paid during the tax year.  40% of the credit is refundable, provided the taxpayer is not: (1) a child under the age of 18 or (2) under the age of 24, a full-time student and is not self-supporting.

For higher-income taxpayers, this credit begins to phase out for AGI in excess of $80,000 ($160,000 for married couples filing jointly), an increase from the previous phase-out thresholds of $50,000/$100,000.

For 2009 and 2010, we have the new “Making Work Pay” credit which the Obama administration says will cut taxes for more than 95% of working families in the United States.  It provides a refundable credit of 6.2% of a taxpayer’s earned income not to exceed $400 for individuals and $800 for joint filing couples.  This credit phases out at the rate of 2% of modified AGI, starting at $75,000 for individuals and $150,000 for joint filers.  It is fully phased out at $95,000 for individuals and $190,000 for joint filers.  Taxpayers can receive this benefit through a reduction in the amount of income tax that is withheld from their paychecks, or through claiming the credit on their tax returns.

Retirees, disabled individuals and Social Security beneficiaries and SSI recipients receiving benefits from the Social Security Administration or Railroad Retirement Board, and disabled veterans receiving benefits from the U.S. Department of Veterans' Affairs will receive a one-time payment of $250 in 2009.  The one-time payment will reduce any allowable Making Work Pay credit.  Thus, taxpayers receiving any of the benefits mentioned above who are working will be required to reduce any otherwise allowable Making Work Pay credit by the $250 one-time payment.  At press time, no date was specified for release of the payments, although the new law specifies payments be made within 120 days of enactment.  Presumably payments will be made in conjunction with the taxpayer’s SS, RR or Veterans payments.

Government retirees who are not eligible for Social Security will also receive the $250, but in the form of a credit on their 2009 tax return, which will reduce any otherwise allowable Making Work Pay credit for 2009.

Taxpayers that itemize their deductions have the option of deducting state income tax or sales tax.  However, if the standard deduction is taken, there is no income tax benefit received from the sales tax that was paid for a vehicle.  Under a provision that applies only to 2009, taxpayers will be allowed to deduct the sales tax paid on the purchase cost of a new motor vehicle, up to a cost of $49,500 ($24,750 if filing married separate). The deduction will be claimed “above-the-line,” thus providing taxpayers with a tax benefit for the tax paid, even if they don’t itemize deductions.  Let’s say the vehicle cost $30,000, sales tax was 8% and the taxpayer was in the 15% tax bracket. He or she would save $360.  This deduction is not available to taxpayers who elect to deduct sales tax in lieu of income taxes as an itemized deduction.  

To keep higher-income taxpayers from benefiting from this deduction, it phases out ratably for a taxpayer with modified AGI between $125,000 and $135,000 ($250,000 and $260,000 on a joint return).

Qualifying vehicles for this deduction are new cars, SUVs, light trucks, or motorcycles weighing no more than 8,500 pounds, and motor homes.

Although some states don’t tax unemployment compensation, it is taxable income for Federal purposes.  Under the new law and for 2009 only, there is no federal income tax on the first $2,400 of unemployment benefits.  However, the balance is taxable.  The benefit of this provision depends upon your tax bracket.  For example, if you are in the 15% tax bracket, this will save you up to $360 in taxes. 

Previous tax law included a 10% tax credit for the cost of home energy-efficient purchases, such as energy-efficient furnaces, hot water boilers, windows, doors, roofing, insulation and other qualified energy-efficient property, and included complicated cost limits on each category along with lifetime caps.  Effective for qualifying items purchased in 2009 and 2010, the credit rate has been increased to 30% with an aggregate cap of $1,500.

Through 2016, individuals are allowed to claim a 30% tax credit for the cost of qualified solar water heating property (capped at $2,000), qualified small wind energy property (capped at $500 per kilowatt of capacity, up to $4,000), and qualified geothermal heat pumps (capped at $2,000).  Under the new law, beginning in 2009, the dollar caps for each of these properties is removed.

For yet another year, Congress has applied a patch to the alternative minimum tax (AMT) to prevent middle-income taxpayers from getting hit by a punitive tax that was originally enacted to counter tax shelters of the wealthy.  

• AMT Exemption Amount Increased - The AMT exemptions have been increased for 2009 to: $70,950 for married individuals filing jointly, $46,700 for unmarried individuals, and $35,475 for married individuals filing separately.  The AMT phase-out rules remain unchanged.

• AMT Relief for Nonrefundable Personal Credits - Nonrefundable personal credits will offset the AMT for 2009.  Those credits include the dependent care credit, elderly and disabled credit, education credits, adoption credit, child tax credit, mortgage credit, saver’s credit, certain residential, home energy credits, first-time homebuyer credit, and plug-in electric vehicle credit.  

Section 529 Education Plans are tax-advantaged savings plans that permit contributions of large sums of money to be used for the education of a designated beneficiary, and investment earnings generated by these plans are tax-free if the funds are used for qualified education expenses.  Qualified education expenses include tuition, room & board, mandatory fees and books.  For 2009 and 2010, computers and computer technology purchases qualify as qualified education expenses, provided the technology, equipment, or services are to be used by the plan beneficiary or his family during any of the years the beneficiary is enrolled at an eligible educational institution.

A credit of $1,000 is available to taxpayers for each qualifying child under age 17 for 2009 and 2010. This credit is phased out depending on income and the number of qualifying children.  Taxpayers with “earned” (not investment) income whose child credit exceeds their regular and alternative minimum taxes are eligible for a refundable credit. This credit is 15% of the taxpayer’s earned income in excess of a threshold amount, which was to be $12,550 for 2009. However, for 2009 and 2010, the threshold amount has been reduced to $3,000, potentially expanding the number of taxpayers who may qualify for the refundable portion of the credit. 

EITC is a refundable tax credit that rewards lower-income individuals for working.  The credit, based upon the amount of the individual’s earned income, is determined through a complicated computation, where the credit increases until the earned income reaches a predetermined apex and then begins to decrease as the amount of earned income increases. As a result the credit becomes zero when the taxpayer is no longer considered a low-income individual.  The amount of the credit is based upon the number of the taxpayer’s qualifying children.  Previously, the categories for the number of children were none, one and two or more. Under the new stimulus legislation for 2009 and 2010, a new category of three or more children has been added and, for that category, the credit will be based on 45% of the earned income instead of the 40% which applies to the category for two children.  This, in effect, temporarily increases the otherwise allowable EIC for taxpayers with three or more children and provides a maximum credit in 2009 of $5,657 when the taxpayer’s earned income is $12,750. 

Joint filing taxpayers will also benefit by having the point at which the EITC phases out for them increased by $1,880 of earned income, to $5,000 for 2009, and to be inflation-adjusted for 2010.  

Businesses are allowed to recover the cost of capital expenditures over time according to a depreciation schedule.  Last year, Congress temporarily allowed businesses to recover the costs of capital expenditures made in 2008 faster than the ordinary depreciation schedule would allow, by permitting these businesses to immediately write-off 50% of the cost of depreciable property (e.g., equipment, tractors, wind turbines, solar panels, and computers) acquired in 2008 for use in the United States.  This temporary provision has been extended through 2009.

In order to help small businesses quickly recover the cost of certain capital expenses, small business taxpayers may elect to write-off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation.  This is commonly referred to as the Sec. 179 deduction.  Until the end of 2010, small business taxpayers are allowed to write-off up to $125,000 (indexed for inflation) of capital expenditures subject to a phase out once capital expenditures exceed $500,000 (indexed for inflation).  Last year, Congress temporarily increased the amount that small businesses could write-off for capital expenditures incurred in 2008 to $250,000, and increased the phase-out threshold for 2008 to $800,000.  Those increased amounts have been extended to 2009.

Under current law, net operating losses (“NOLs”) may be carried back to the two taxable years before the year that the loss arises (the “NOL carryback period”) and carried forward to each of the succeeding twenty taxable years after the year that the loss arises.  For NOLs for any tax year beginning or ending in 2008, the bill extends the maximum NOL carryback period from two years to five years for small businesses with gross receipts of $15 million or less.

This provision provides a credit to an employer for qualified wages paid to members of targeted groups.  The credit, except for long-term family assistance recipients and summer youth employees, equals 40% (25% for employment of 400 hours or less) of qualified first-year wages ($6,000 cap) for a maximum credit of $2,400.  For employment beginning in 2009 and 2010, wages paid to two new targeted groups – unemployed veterans and disconnected youth – count towards the credit. 

An individual will qualify as an unemployed veteran if they were discharged or released from active duty from the Armed Forces during the five-year period prior to hiring, served on active duty for more than 180 days or was released from active duty due to a service-connected disability, and received unemployment compensation for not less than four weeks during the year before being hired.  An individual qualifies as a disconnected youth if they are between the ages of 16 and 25 and have not been regularly employed or attended school in the past 6 months.

Some years ago, to prevent higher-income taxpayers from creating large tax writes-offs from expensive vehicles, Congress implemented the “Luxury Auto Limitations,” which places a cap on first-year depreciation.  The provision that extends the 50% first-year bonus depreciation to 2009 purchases (mentioned elsewhere in this article) also extends the increased dollar cap for new vehicles placed in service in 2009 by $8,000. The regular luxury auto depreciation caps for 2009 have not yet been announced by the IRS. For 2008 the regular cap was $2,960 but was increased to $10,960 when the 50% bonus depreciation was claimed. The 2009 amount will likely be similar.

To encourage the risk of forming new small businesses (sales of $50 million or less), the tax code (Sec. 1202) has for some time allowed taxpayers to exclude fifty percent (50%) of the gain from the sale of certain small business stock held for more than five years.  The amount of gain eligible for the exclusion is limited to the greater of 10 times the taxpayer’s basis in the stock, or $10 million in gain from stock in that small business corporation.  This provision is limited to individual investments and not the investments of a corporation.  The non-excluded portion of section 1202 gain is taxed at the lesser of ordinary income rates or 28 percent, instead of the lower capital gains rates for individuals.  A provision in the Recovery Act allows a seventy-five percent (75%) exclusion for individuals on the gain from the sale of certain small business stock held for more than five years.  This change is for stock issued after the date of enactment and before January 1, 2011.  There are also some alternative minimum tax implications associated with the sale; please call this office for additional information.   

For vehicles bought after February 17, 2009 and before January 1, 2012, the Recovery Act creates a new 10% nonrefundable personal credit for low-speed vehicles, motorcycles, and three-wheeled vehicles that meet the criteria of a qualified plug-in electric drive motor vehicle.  The maximum credit for these vehicles is $2,500.  If the vehicle is also used in business, the business portion of the credit is treated as a general business credit.  Four-wheel vehicles purchased after January 1, 2009 also qualify for this credit based on a law passed in 2008.  There are additional qualifications, so please call for further details.

Under current law, if a taxable corporation converts into an S corporation, the conversion is not a taxable event.  However, following such a conversion, an S corporation must hold its assets for ten years in order to avoid a tax on any built-in gains that existed at the time of the conversion.  The bill temporarily reduces this holding period from ten to seven years for sales occurring in 2009 and 2010.

Last year, the Treasury Department issued Notice 2008-83, which liberalized rules in the tax code that are intended to prevent taxpayers that acquire companies from claiming losses that were incurred by the acquired company prior to the taxpayer’s ownership of the company.  The bill would repeal this Notice prospectively.