Earlier this week, the House Ways and Means committee came to an agreement for key legislation to renew the so-called Tax Extenders, a series of tax provisions that have lapsed and been reinstated (i.e., extended) repeatedly over the past decade. The new legislation, entitled the Protecting Americans from Tax Hikes (PATH) Act of 2015, will once again retroactively reinstate for 2015
Unlike past tax extenders legislation, though, this time many of the provisions are permanently renewed. From the popular qualified charitable distribution rules for making charitable contributions from an IRA for those over age 70 ½, to the American Opportunity Tax Credit for college, and the deduction for state and local sales taxes, this will be the last time that these key tax planning provisions remain in an end-of-year limbo!
However, not all tax extenders provisions were made permanent; a few, such as 50% bonus depreciation for businesses and the work opportunity tax credit, are only extended a few years. The legislation also includes a few new tweaks, from a slight expansion of how qualified distributions from section 529 plans can be used, to the elimination of in-state-plan requirement for the coming new 529-ABLE plans for disabled beneficiaries.
Although the PATH legislation has not quite passed yet — it still needs to be Omnibus Appropriations legislation that sets the government’s budget through September 30 of 2016 — the tax extenders expected to pass in its agreed-upon form in a matter of days, once the remainder of the rulemaking process is completed.
And notably, the final version of the Omnibus legislation will not include any changes to the Department of Labor’s fiduciary proposal, which remains intact and on track for the DoL to issue its final year in the coming months!
KEY TAX EXTENDERS
In its final form, H.R. 2029 — also known as the Protecting Americans from Tax Hikes (PATH) Act of 2015 —
Notably, unlike prior versions of the tax extenders legislation, the PATH Act will temporarily reinstate some provisions but permanently extend others. A list of the key provisions and changes is noted below.
(For a full list of the provisions, see the Section-By-Section Summary Of The
QUALIFIED CHARITABLE DISTRIBUTIONS (QCD) DIRECTLY FROM IRAS TO CHARITIES MADE PERMANENT
Since 2006, taxpayers who are over age 70 ½ have been permitted to make a “Qualified Charitable Distribution” of up to $100,000 directly from an IRA to a charity. The contribution to the charity is not claimed as a tax deduction, but the distribution from the IRA is not taxed in income in the first place either, making it a “perfect” pre-tax charitable contribution. And the QCD counts towards the taxpayer’s Required Minimum Distribution obligations, which would apply given that he/she must already be over the age of 70 ½.
The new PATH tax extenders legislation makes the Qualified Charitable Distribution rules permanent, at their existing levels and thresholds (still capped at $100,000 per taxpayer, and still must be over age 70 ½ at the time of the distribution).
For those
Notably, though, from a tax perspective it is still better to
STATE AND LOCAL SALES TAX DEDUCTION MADE PERMANENT
Each year, taxpayers may claim an itemized deduction for either the payment of state income taxes in the calendar year, or the payment of state sales taxes instead. The state sales tax deduction can be determined by adding up the actual state sales taxes paid (and validated by receipts), or
Generally, taxpayers will claim whichever amount is higher — state income taxes paid, or state sales taxes paid (based on receipts or the IRS estimate methodology) — to produce the largest deduction on Schedule A.
Notably, given that sales taxes apply only to goods that are purchased, while state income taxes apply to all income in the year, the state income tax deduction is typically higher in any states that have an income tax, and the state sales tax deduction is usually only claimed by those who live in states without an income tax (i.e., Florida, Texas, Nevada, South Dakota, Alaska, Washington, and Wyoming).
The new PATH tax extenders legislation makes the state and local sales tax deduction permanent. This change will primarily benefit those who itemize their deductions, and live in one of the aforementioned seven states that have no income tax (though individuals with low income and high expenses in other states, including retirees liquidating investment accounts in retirement, may still find the state sales tax deduction appealing).
ENHANCED AMERICAN OPPORTUNITY TAX CREDIT MADE PERMANENT
In the past, college students were eligible for a $1,800 Hope Scholarship Credit for tuition and related expenses in the first two years of post-secondary education (and after the first two years, students and their families would claim the less-favorable
In 2009 under the American Recovery and Reinvestment Act, the Hope Scholarship Credit was changed to become the American Opportunity Tax Credit, expanding the credit to $2,500/year, allowing it for up to four years of post-secondary education, and raising the AGI phaseouts to $160,000 for married couples (and $80,000 for individuals).
The American Opportunity Tax Credit was scheduled to lapse (and revert back to the ‘old’ Hope Scholarship Credit) at the end of 2017.
The new PATH tax extenders legislation makes the American Opportunity Tax Credit permanent.
ENHANCED CHILD TAX CREDIT MADE PERMANENT
The
For lower-income individuals, who do not even have a $1,000 tax liability, the child tax credit becomes a refundable credit (called the “
The new PATH tax extenders legislation makes the $3,000 threshold permanent for calculating the additional refundable portion of the child tax credit.
Example: For a lower income couple that has earned income of only $15,000 per year and no tax liability (due to the standard deduction and personal exemptions), the enhanced child tax credit makes it possible to receive the entire child tax credit of $1,000 (since $15,000 of earned income is $12,000 over the threshold, and 15% of $12,000 is more-than-enough to permit the $1,000 credit); under the “old” rules (were they to have been reinstated after 2017), a couple earning $15,000 would have only received less than a $150 child tax credit (15% of the $1,000 excess of their earned income over the $14,000 threshold which would have been higher with inflation indexing by 2018).
SCHOOL TEACHER EXPENSE DEDUCTION ENHANCED AND MADE PERMANENT
Elementary and secondary school teachers are eligible for
The new PATH tax extenders legislation makes the educator expense deduction permanent. In addition, the legislation also indexes the $250 cap for inflation beginning in 2016 (but rounded to the nearest $50, so the first increase may not happen until subsequent years), and also beginning in 2016 expands the eligible schoolteacher expenses to include professional development expenses in addition to in-classroom school teacher supplies.
EXCLUSION OF DISCHARGED MORTGAGE DEBT ON QUALIFIED PRINCIPAL RESIDENCE EXTENDED THROUGH 2016
Under normal tax rules,
To provide some relief for this situation as the real estate market started to decline (accelerated by the financial crisis), the
The new PATH legislation extends the discharge of mortgage debt on a qualified principal residence rules through the end of 2016 (but not permanently), and also provides that debt discharged in 2017 will qualify as long as it occurs pursuant to a written agreement entered into in 2016.
For those who engaged in the short sale of a home this year, the new provision will be a welcome (retroactive) relief. Anyone who is still facing an underwater mortgage and considering a sale of the primary residence in the future may still wish to consider whether to complete the sale in 2016 (or at least, enter into a contract to sell in 2016) to avoid potentially unfavorable tax consequences in 2017.
DEDUCTIBILITY OF MORTGAGE INSURANCE PREMIUMS AS QUALIFIED RESIDENCE INTEREST EXTENDED THROUGH 2016
For those who pay mortgage insurance premiums (e.g.,
This
The new PATH legislation extends the mortgage insurance premiums deduction for qualifying mortgage insurance premiums through the end of 2016.
ABOVE-THE-LINE EDUCATION DEDUCTION FOR QUALIFIED TUITION AND FEES EXTENDED THROUGH 2016
For those with children in college, an alternative to claiming the American Opportunity Tax Credit or the Lifetime Learning Credit is to claim the
In practice, the above-the-line education deduction is rarely claimed, because the deduction only provides a benefit based on
Nonetheless, the new PATH legislation extends the above-the-line tuition and fees education deduction through the end of 2016.
Other Miscellaneous Tax Extenders Provisions Of The PATH Act Of 2015
Although not germane to most financial planners, other notable provisions extended or made permanent in the PATH legislation includes:
– Section 179 Expensing. The favorable Section 179 expensing limits, including the $500,000 maximum deduction amount and the $2,000,000 threshold for phasing out the deduction, are retroactively reinstated for 2015 (after having been
– 50% Bonus Depreciation. The rules are reinstated for 2015 and extended at current levels through 2017. In 2018 the bonus depreciation rules will continue but as 40% bonus depreciation. In 2019 the 40% will be reduced to 30%. Bonus depreciation would then end altogether after 2019.
– Work Opportunity Tax Credit. The
– Section 1202 Small Business Stock Capital Gains Exclusion. The
– Qualified Conservation Contributions. Favorable rules allowing for
OTHER NOTABLE TAX EXTENDER PROVISIONS
In addition to the tax extenders discussed above, the PATH Act of 2015 also includes a few additional changes that were included. Notably, many looming “crackdowns” on popular planning strategies, from
A few notable changes that were included are:
IMPROVEMENTS TO SECTION 529 ACCOUNTS
Under new rules, qualified higher education expenses will now include computer equipment and related expenses (including computer software and even Internet access), permitting distributions for such expenditures from a Section 529 plan to still qualify for tax-free treatment.
Also changed under the new rules is the elimination of the Section 529 plan aggregation rule, which required all 529 plans under IRC Section 529(b)(3)(D) to be aggregated together to determine the amount of each distribution that would be return-of-principal versus gain. Under the new rules, each 529 account distribution is taxed based only on the gains and principal in that account. For qualifying tax-free distributions from a 529 plan, this provision is a moot point, but would be relevant for those making a non-qualified distribution (taxable as ordinary income plus a potential 10% early/non-qualified withdrawal penalty).
In situations where a 529 plan distribution is used to pay college tuition that is subsequently refunded and thus not actually used for college (which would render the distribution ineligible for tax-free treatment after the fact!), the new rules will permit such amounts to be re-contributed (i.e., roll over) back to the 529 account within 60 days.
EXPANSION OF 529 ABLE ACCOUNTS TO USE ANY STATE PLAN (RESIDENCY REQUIREMENT ELIMINATED)
The
Under the original rules, though, the beneficiary of the 529 ABLE plan would have been required to use the plan in his/her state of residence. The original provision was there to facilitate the fact that after the beneficiary’s death, there is a Medicaid payback requirement that the state be repaid from any remaining 529 ABLE balance for prior Medicaid expenditures on the beneficiary’s behalf. Each state was expected to have its own single plan for special needs beneficiaries in its state, and states had the option to subcontract out their own state’s plan to another state (but the beneficiary was still “stuck” with whatever plan his/her home state offered).
Under the new rules, the residency requirement for these tax-qualified plans is eliminated, and individuals will be permitted to choose any state’s 529 ABLE plan (allowing them to have more control over investment options and expenses, and even the state-based maximum account limits.)
Ultimately, the good news of this tax extenders legislation is that with permanence for most key provisions, the repetitive here-gone-back-again process of planning with these rules is eliminated. This should be especially helpful for rules like the Qualified Charitable Distributions from IRAs, which have been plagued for years with challenging scenarios where retirees needed to take their RMDs, wanted to do a QCD, but weren’t certain whether the rules would be reinstated in time to do it. And of noted earlier, the permanence of tax extenders was done without the looming potential of other crackdowns that may have adversely impacted planning strategies for clients.
With the conclusion of this tax legislation, we are likely done for any tax laws through the end of President Obama’s presidency. It is no longer even clear if Congress will take up tax legislation again next December in a lame duck session, given that so few provisions have a looming lapse at the end of 2016 anyway (and even then, they would more likely be allowed to lapse in 2016 and then taken up as potential retroactive tax extenders in 2017).
Nonetheless, while this may be the last substantial tax legislation under after the next election and inauguration, the stage is still set for potentially significant tax reform legislation coming in 2017!
Michael Kitces, CFP, is a Financial Planning contributing writer and a partner and director of research at
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