Tax Planning Opportunities Under The Stimulus Plan

On February 17, 2009, President Obama signed Public Law 111-5, the American Recovery and Reinvestment Act of 2009 (ARRA), containing $787 billion in tax cuts and spending.

In this special report, Eisner LLP summarizes the primary tax and related components of the ARRA and adds brief observations on them, as well as on certain other tax proposals which could become law.

1. Expanded Business Expensing, Loss Carryback, Income Deferral and Credit Provisions

Increased Expensing Provisions

The ARRA includes an extension of the current bonus depreciation provision to cover eligible assets placed in service in 2009. This provision allows taxpayers to deduct immediately 50 percent of the acquisition cost of eligible assets, including, among others, those with depreciable lives of 20 years or less, certain computer software and qualified leasehold improvement property.

The ARRA also extends, for property placed in service in 2009, the provision allowing a company to monetize Alternative Minimum Tax (AMT) credits and research and development (R&D) credits, in lieu of the bonus depreciation described above. This provision allows such companies to elect to receive 20 percent of the value of unused AMT or R&D credits to the extent they invest in assets that would qualify for bonus depreciation. The amount is capped at the lesser of 6 percent of the outstanding unused AMT and R&D credits or $30 million.

Observation: This provision helps taxpayers who are in the AMT or who have current year losses and may not be able to benefit from bonus depreciation.

Another tax benefit in the ARRA allows small businesses to immediately expense acquired capital assets. An existing provision allows businesses to expense up to $125,000 (subject to a phase-out) of eligible capital acquisitions through 2010; in 2008 Congress temporarily increased, only for 2008, the deductible amount to $250,000 (phased out beginning at $800,000 in capital asset acquisitions). The increased $250,000 deduction amount is extended to 2009, retroactive to January 1, 2009.

Observation: This immediate deduction may encourage small businesses to make additional capital asset acquisitions during 2009.

Increased Net Operating Loss Carryback Provision

The ARRA extends the carryback period for net operating losses (NOLs) generated in 2008 - for this purpose, including taxable years beginning or ending in 2008 - to the previous five years, but only for small businesses with gross receipts of not more than $15 million per year. The gross receipts test is met if the average annual gross receipts for the previous three years are $15 million or less. A taxpayer is presently allowed to carry back a current year NOL to generate a refund of income taxes if the taxpayer had income in the previous two years. The five-year carryback period may allow the recovery of tax payments made in prior years, which can be applied by taxpayers who operate small businesses that have been struggling in the current climate.

Observations: Some major business trade associations had suggested that many companies will not have had income in 2007 and 2008 in an amount sufficient to absorb losses expected to be generated in 2009; this could also limit the impact of the proposed increased expensing provisions discussed earlier. However, as a result of the conference committee compromises on the ARRA, the increased carryback period for small businesses applies only to NOLs generated in taxable years beginning or ending in 2008, not 2009. Small businesses with taxable years beginning part way through 2008, however, may have losses in the 2009 portion of their current taxable years, which can benefit from the five-year carryback.

In addition, more guidance may be helpful on the treatment of small corporations that are part of a large affiliated group. For example, can a small corporation's loss be carried back to offset the taxable income of any consolidated corporation in the prior five-year period, even one with more than $15 million in gross receipts? A consolidated group only has the opportunity to carry back a consolidated net operating loss (commonly referred to as the CNOL). However, the ARRA seems to link the $15 million threshold to the taxpayer generating the loss and each member of the affiliated group generates its own NOL.

Companies Receiving TARP Benefits

The ARRA clarifies that compensation deduction and payment limits enacted in the fall of 2008 apply to all companies receiving TARP benefits. However, the ARRA does not contain an excise tax on excess compensation paid.

Cancellation of Indebtedness

Observation: The ARRA significantly encourages business restructurings by allowing - even outside bankruptcy proceedings - delayed recognition of certain businesses' cancellation of debt income (CODI).

The ARRA provides that a business that recognizes CODI in connection with a reacquisition of its debt during 2009 or 2010 generally may elect to recognize such income at 20 percent per year over the five years beginning in 2014, rather than immediately. This election applies to an acquisition of debt by the company itself or by a related person, whether as an exchange of the debt for cash, other debt, or equity, a significant modification of the debt, a contribution of the debt to capital or forgiveness of the debt. There is no reduction of tax attributes as a result of the deferral. Special rules provide for such CODI recognized by a partnership.

If such reacquired debt is treated as reissued with additional original issue discount (OID), the deduction for such additional OID must be deferred until the five-year period when the CODI is recognized, even though the holder of the modified debt must include the OID income as it accrues over the term of the debt.

In addition, the applicable high yield discount obligation rules - which generally limit interest deductions on high yield debt - will not apply to debt issued between the beginning of September 2008 and the end of 2010 in certain exchanges for pre-existing debt.

The ARRA also contains statutory authority to extend the effective date and to use a higher rate for the determination of whether there is high yield.

Work Opportunity Tax Credit

The ARRA includes an expanded work opportunity tax credit to employers which hire in 2009 or 2010 disconnected youth or unemployed veterans discharged during the five years prior to being hired.

Low-Income Housing Credit

For taxpayers without sufficient tax liabilities to use the existing low-income housing tax credit, the ARRA provides a tax-free HUD grant option for low-income housing investment.

2. Pre-Acquisition Losses

Banks and Financial Institutions

Generally, under current law, if an acquired corporation has an unrealized built-in loss, the ability of the purchaser to utilize the loss against post-acquisition income is limited. However, in IRS Notice 2008-83 , the U.S. Treasury Department announced that any deduction properly allowed after an ownership change to a bank with respect to losses on loans or bad debts would not be treated as a built-in loss. The ARRA includes a prospective repeal of this Notice, except for ownership changes pursuant to written agreements entered into and publicly announced on or before January 16, 2009.

Observation: This repeal will limit the use of pre-acquisition bank losses by an acquiror.

Other Pre-Acquisition Losses

The ARRA clarifies that the restriction on use of pre-acquisition losses generally does not apply to restructurings that are required under loan agreements with the U.S. Treasury Department pursuant to the Emergency Economic Stabilization Act of 2008.

3. Corporate Tax Payments and S Corporation Holding Periods

Tax Rates and Estimated Tax Payments

The ARRA does not alter present corporate income tax rates. However, independent of the ARRA, on February 4, 2009, the President signed into law HR 2, the Children's Health Insurance Program Reauthorization Act of 2009 . This legislation provides health insurance to children living in families not eligible for Medicaid but unable to afford private health insurance. Revenue generation offsets include provisions that increase the federal excise tax on tobacco products and make changes to the timing of certain estimated tax payments by corporations with assets of at least $1 billion.

S Corporations

The ARRA temporarily shortens the holding period of S corporation assets which can be sold without tax on built-in gains from ten years to seven years, for sales occurring in 2009 and 2010.

Observation: This may encourage conversion of S corporations to pass-through entities.

4. Individual Income Tax Rates and Alternative Minimum Tax Modifications

The ARRA does not include any income tax rate cuts or tax rate changes for net long term capital gains or qualified dividends.

Observation: The present rates under the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003 will remain in effect through 2010, unless modified in future legislation. After 2010 and if not changed by future legislation, the higher tax rates up to 39.6 percent for ordinary income and 20 percent for net capital gains that were in effect prior to 2001 will apply.

Alternative Minimum Tax

The ARRA includes a one year "patch" for 2009 to reduce the application of the AMT to middle-class taxpayers. The AMT exemption amount is increased for a joint return filer (or a surviving spouse) from $69,950 for 2008 to $70,950 for 2009; and for a single person from $46,200 for 2008 to $46,700 for 2009.

These exemption amounts will phase out at certain levels of income: for a joint return filer the range for 2009 is $150,000 to $433,800 and for a single filer for 2009 the range is $112,500 to $299,300.

Observation: Even with these relatively small income exemption increases of $500-1,000, the one-year patch has been estimated to cost almost $70 billion. However, for many higher-income taxpayers and others living in high-tax states, this AMT relief will not apply.

The ARRA also extends for one more year the AMT relief for personal tax credits (if not refundable to a taxpayer who is not able to use the credits) through 2009.

Unemployment Benefits

The ARRA suspends federal income tax on the first $2,400 of unemployment benefits in 2009.

Small Business Stock

The ARRA increases the income tax exclusion - from 50 percent to 75 percent - for an individual's gain from the sale of certain qualified small business stock acquired in 2009 or 2010 and held for more than five years, effectively reducing the federal regular tax on gains from such stock to 7 percent.

Observation: This change makes the potential savings more meaningful than in the past. For federal regular tax purposes, the maximum rate of tax on such gains is now 7 percent (as opposed to 15 percent). For AMT purposes, the maximum rate is now 8.47 percent (as opposed to 15 percent).In addition, the increased exclusion should apply in many states that follow the federal rules.

Thus it is more important than ever to identify and track qualified small business stock held by individuals, either directly or indirectly through pass-through entities. In addition, it will now be necessary to identify and track the acquisition date with respect to gains from the sale of qualified small business stock. Gains from qualified small business stock acquired outside of the above date range will still be eligible for the 50 percent exclusion. However, the maximum regular federal tax rate on such gains will be 14 percent (as opposed to 15 percent); for AMT purposes the maximum rate will be 14.98 percent (as opposed to 15 percent).

Estimated Tax Payments

The ARRA decreases estimated tax requirements for qualified individuals with small businesses.

Observation: Individuals should be able to obtain this reduction from a pass-through entity.

5. Enhanced Tax Credits and Deductions for Individuals

Observation: Many of the credits and refunds described below are either explicitly applicable only for low-income individuals, or begin to phase out for individuals with income of more than $75,000-80,000 (or for joint filers with income of more than $150,000-160,000). This may encourage individuals to manage their income levels for 2009 onwards.

Earned Income Tax Credit

The ARRA provides for an increase in the earned income tax credit for 2009 and 2010 for a family with three or more children, to 45 percent from 40 percent of the family's first $12,570 of earned income, with a phase-out of the credit beginning at an increased amount of $21,420 in income for couples filing a joint return.

"Making Work Pay" Tax Credit

The goal of the Making Work Pay tax credit is to provide a refund to each individual equal to part of his or her Social Security tax payments for 2009 and 2010. The ARRA provides a maximum credit of $400 for single persons and $800 for couples. For most wage earners, this credit will be reflected in reduced withholding from their paychecks. The credit phases out as income exceeds $75,000 for single filers and $150,000 for couples.

Child Tax Credit

Under current law, a taxpayer receives a $1,000 tax credit for each qualifying child under age 17. The credit is reduced by $1 for every $50 of modified adjusted gross income in excess of certain amounts ($110,000 joint/$75,000 if single). To the extent that the credit exceeds the taxpayer's tax liability, the taxpayer is eligible for a refund equal to 15 percent of earned income in excess of a certain amount (or the amount of the unclaimed credit, if less). The Emergency Economic Stabilization Act of 2008 reduced this threshold amount to $8,500 for 2008 and this amount was to be $12,550 (as indexed for inflation) in 2009. The ARRA provides that for any taxable year beginning in 2009 or 2010 the portion of the credit that is refundable is 15 percent of earned income in excess of $3,000. (Under current law, taxpayers with 3 or more children use an alternative method to compute their refundable amount if it results in a greater refund; the new law does not change this alternative method.)

Observation: The new law does not change the amount of the credit; it only makes the portion of the credit that is refundable greater, by a maximum of $1,433 ([$12,550-$3,000] x 15 percent), for taxpayers whose tax liability is so low that it is less than the credit.

American Opportunity Tax Credit

The ARRA provides, for any taxable year beginning in 2009 or 2010, an increase in the Hope scholarship credit to equal the sum of 100 percent of qualified tuition and related expenses paid by the taxpayer during the taxable year (for education furnished to the eligible student during any academic period beginning in 2009 and 2010) not to exceed $2,000, plus 25 percent of such expenses so paid in excess of $2,000 but not to exceed $4,000. The credit is allowed for the first four years of post-secondary education for qualified tuition and related expenses, including required course materials.

The potential $2,500 credit is reduced by the amount that bears the same ratio to such credit as the excess of the taxpayer's modified adjusted gross income for such taxable year over $80,000 ($160,000 for a joint return) bears to $10,000 ($20,000 for a joint return). For example, for joint return filers with such income of $180,000 or more, the potential credit is eliminated.

The credit is allowed against the AMT as well. If the taxpayer cannot use all of the credit as a tax credit, up to 40 percent of the credit is refundable. However, the credit is not refundable in the case of a child who is subject to the so-called kiddie tax.

Observation: Many children may be eligible for this refundable credit, but its interaction with the kiddie tax must be understood to confirm their eligibility. Moreover, a child claiming the credit may not be claimed as a dependent.

Education Expenses

The ARRA expands the definition of qualified education expenses for Section 529 education savings plans, to include computer technology and equipment.

First-Time Home Buyer Tax Credit

Legislation enacted in 2008 provided a $7,500 tax credit for first-time home buyers purchasing a home between April 2008 and June 2009, and was designed to be repaid by taxpayers without interest to the Internal Revenue Service over a 15-year period. The credit phases out for taxpayers with adjusted gross income in excess of $75,000/$150,000 (single/joint filers). In addition, a standard deduction (for those who do not itemize) of up to $500 ($1,000 for joint filers) is available for the 2008 tax year for property taxes paid.

The ARRA increases the credit to $8,000 and eliminates the repayment obligation for taxpayers who purchase homes between January and November 2009, subject to recapture if the property is sold or ceases to be the taxpayer's primary residence (not just a principal residence) within three years of purchase.

Observation: This increased and non-repayable credit for first-time home buyers between January and November 2009 is much reduced from a credit of up to $15,000 for all home buyers, which was proposed in the Senate version of the ARRA.

A taxpayer who purchases a home in 2009 - as opposed to 2008 - may not qualify for the full nonrepayable credit because of higher income in 2009 than in 2008.

Observation: The ARRA allows such an individual to elect to treat the 2009 home purchase as if made in 2008, to qualify for the higher and nonrepayable credit if income limits were met in 2008.

The ARRA also now allows the purchaser of a home financed with the proceeds of a mortgage revenue bond (i.e., a qualified mortgage issue the interest of which is tax-exempt) to take advantage of the first-time home buyer credit.

Plug-in Electric Motor Vehicle Credits

Taxpayers who purchase certain plug-in electric drive motor vehicles have been able to claim a tax credit (the so-called Sec. 30D credit) for the sum of: (1) $2,500; plus (2) $417 for each kilowatt hour of traction battery capacity in excess of 6 kilowatt hours. The tax credit was limited to amounts ranging from $7,500 to $15,000 based on the weight of the vehicle. Under the ARRA, the Sec. 30D credit is modified for vehicles bought after 2009. Purchasers of qualifying electric vehicles will now be eligible for a credit which is the sum of: (1) $2,500; plus (2) $417, in the case of a vehicle that draws propulsion energy from a battery with not less than 5 kilowatt hours of capacity, plus $417 for each kilowatt hour of battery capacity in excess of 5 kilowatt hours. The amount of the credit so computed is limited to $5,000.

The ARRA also created two new tax credits for qualified plug-in electric drive motor vehicles. First, a new 10 percent nonrefundable personal credit applies to electric drive low-speed vehicles, motorcycles, and three-wheeled vehicles bought between February 18, 2009 and the end of 2011. The maximum credit for these vehicles is $2,500.

Second, for property placed in service between February 18, 2009 and the end of 2011, the ARRA creates a new 10 percent credit, up to $4,000, for the cost of converting any motor vehicle into a Sec. 30D qualified plug-in electric drive motor vehicle.

Additional Car Buyer and Commuter Benefits

The ARRA provides "above the line" income tax deductions to car buyers for sales and excise taxes on auto purchases through 2009 (but not auto loan interest payments). This deduction phases out for taxpayers with more than $125,000 of income.

The ARRA also equalizes tax-free transit and parking benefits at $230 per month.

Observation: There is no income limit on this tax-free fringe benefit.

6. Retirement Savings and Estate Taxes

The ARRA contains no provisions regarding retirement plan distributions or modifications to existing qualified retirement plans, nor any provisions impacting current or expiring estate tax provisions.

However, President Obama is on record as desiring to retain the estate tax and freeze the applicable estate exclusion amount of $3.5 million, while maintaining the current top tax rate of 45 percent. Legislation may include a provision making the $3.5 million exclusion amount portable between spouses. Such a provision would allow the surviving spouse to utilize the unused proportion of the decedent spouse's applicable exclusion amount. (It should be noted that many states do not conform to the federal estate tax rules.)

In addition, U.S. Rep. Earl Pomeroy (D-ND) sponsored, on January 9, 2009, HR 436 that would retain the estate tax with a $3.5 million exclusion. The Pomeroy proposal would also impose a 5 percent surcharge on estates valued between $10 million and $41.5 million. HR 436 was referred to the House Ways and Means Committee and is currently awaiting Committee member review.

An additional proposal contained in HR 436 would eliminate valuation discounts for marketability and minority interests for transfers of any interest in an entity unless the interest is actively traded. The marketability discount would be eliminated under the proposal if the non-actively traded business does not carry on a trade or business (e.g., a family limited partnership holding securities).If the entity does carry on a trade or business but also has non-business assets, those assets would be removed from the valuation of the entity and valued without a discount.The entity would still be entitled to a marketability discount after the non-business assets are removed.

Minority interest discounts would not be allowed in the valuation of a non-actively traded business if the taxpayer (through attribution) owns or controls more than 50 percent of the business (whether or not such entity carries on a trade or business). A similar proposal was included eight years ago in the Administration's Fiscal Year 2001 Budget. The reasons for that proposed change included the proposition that the use of family limited partnerships and similar devices is eroding the tax base and that it is implausible that a donor would intentionally take actions (contributing property to an entity) if the donor really believed that such action would cause the family's estate to decline substantially.The new proposal introduces a family attribution concept:if a family owns control of the asset, then there would be no minority interest discount allowed, whether the assets are active or passive.

HR 436 as drafted would be effective for transfers occurring after the date of enactment. There is always the possibility, however, that any final statute might be applied retroactively.

Observation: In summary, should HR 436 become law, discounts would not be allowed to apply to non-business assets held by partnerships or other entities.Rather, the assets held by the entities would be valued as though they were transferred directly by the recipient.Further, if a family controls an entity that is not actively traded, no discounts would be allowed for the transferee's lack of control.

Thus, family-owned entities may want to consider the potential impact of this potential legislation in reviewing their current estate plans and any proposed transfers.

7. Energy Provisions

Renewable Energy Production Tax Credit (REPTC)

The current REPTC generally provides a tax credit of 1.9 cents per kilowatt hour of electricity generated by certain renewable energy facilities. The ARRA includes a multi-year extension beyond 2010 of the tax credit for wind, geothermal, hydro, and bioenergy electricity generation facilities, with a temporary election to claim the investment tax credit in lieu of the REPTC.

Observation: For taxpayers without sufficient tax liabilities to use the credit, the ARRA permits projects eligible for the REPTC to elect to participate instead in a U.S. Department of Energy grant program whose grants are not includible in gross income.

Additional Energy Credits

The ARRA includes tax credits for energy conservation, energy efficiency, and renewable energy research expenditures. In addition to expanded credits for plug-in electric drive vehicles as described further above in connection with other auto buyer and commuter benefits, the ARRA also expands credits for alternative fuel refueling property and for other energy expenditures.

For example, the ARRA allows an individual up to $1,500 in tax credits for qualified nonbusiness energy efficiency improvements and residential energy property expenditures. Previously, an individual could claim a nonbusiness energy property credit for energy efficient improvements to the individual's primary residence. The credit was equal to 10 percent of the amount paid for qualified energy efficiency improvements installed during the year, increased by a fixed dollar amount for certain residential energy property expenditures (e.g . , fans, furnaces, and energy efficient heat pumps, water heaters and central air conditioners).

The ARRA modifies and extends the energy property credit by increasing the credit to 30 percent, including certain residential energy property expenditures for which the credit was previously capped.AARA eliminates the $500 lifetime cap on the credit by replacing it with a $1,500 aggregate credit for property placed in service in 2009 or 2010 and imposes new efficiency standards.

Observation: For taxpayers who are planning residential improvement projects, this credit can help finance energy efficiency expenditures.

The ARRA also contains an important new 30 percent investment tax credit for facilities engaged in the manufacture of advanced energy property.

Observation: The aggregate credits under this new provision cannot exceed $2.3 billion, to be allocated by the U.S. Department of Energy under an elaborate program for certifying projects for the credits. This may make it difficult for sponsors to make project expenditures quickly in reliance on the credits.

The ARRA also repeals the existing reduction of the investment tax credit for property financed with subsidized energy financing.

Energy Bonds

The ARRA creates additional tax-advantaged Clean Renewable Energy Bonds and Qualified Energy Conservation Bonds, to promote financing of renewable energy facilities and energy conservation expenditures.

8. Government Bonds and Projects

The ARRA changes several rules to make it easier for financial institutions to invest in municipal bonds.

The ARRA also repeals the AMT income inclusion for tax-exempt income from new private activity bonds issued in 2009 or 2010.

Observation: This change may make municipal bonds more attractive, when coupled with the extensive financial support for state and local governments under the ARRA's investment and spending provisions.

In addition to the provisions for bonds and tax credits promoting renewable energy and conservation as noted above, various tax-exempt and tax-credit bonds are authorized to spur development in recovery zones with high unemployment, tribal economic development, high speed rail and broadband. For example, the ARRA provides for $15 billion in recovery zone facility bonds and $10 billion in recovery zone economic development bonds. The ARRA also creates a new category of tax credit bonds for public school facilities and land and expands existing authority for qualified zone academy bonds.

Observation: The ARRA includes a taxable bond option for local government bonds issued in 2009 and 2010 - so-called Build America Bonds - which includes a tax credit of 35 percent of interest payable to purchasers, instead of tax-exempt interest. Since the private investment market for tax credits may be limited for a time, the issuing authority of bonds issued in 2009 or 2010 may also receive a direct payment from the federal government equal to the tax credit.

Property for which manufacturing facilities are eligible for tax-exempt bond financing is expanded to include intangible property .

The ARRA delays through 2011 implementation of a new 3 percent withholding requirement on government contractors.

9. Health Policies

The ARRA provides for COBRA premium subsidies of 65 percent for up to 9 months following involuntary termination of employment between September 2008 and the end of 2009. It also gives employers more time to administer the subsidies and allows COBRA-eligible individuals to change coverage options.

10. Investment and Spending Provisions

Among the non-tax spending provisions and consistent with the President's objectives, the ARRA provides major funding for energy, science, infrastructure, education and healthcare, re-employment and training, and relief for the states.

A controversial component is a Buy American provision which requires most projects to be built entirely with U.S. products.

Observation: The ARRA requires this limitation to be applied in a manner consistent with U.S. agreements with its trading partners.

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