In December 31, 2014, 52 provisions of the Internal Revenue Code expired. Among the provisions that died on that day were powerful business incentives like the R&D credit, bonus depreciation, and enhanced Section 179 write-offs of asset acquisitions. Individual taxpayers were not immune to the lapse in law; we lost the itemized deduction for state and local sales taxes in lieu of income taxes and the exclusion for cancellation of debt income related to primary residence mortgages when the clock struck midnight on New Year’s Eve 2014.
Not knowing if these provisions would be brought back for 2015 this late into the year is nothing new. Nor did it mean these sections of the law couldn’t be reinstated retroactively for all of 2015; in fact, that has become the norm in recent years. To wit, these same 52 provisions expired on December 31, 2013, only to be retroactively resuscitated for all of 2014 on December 21st of last year. Of course, this meant that we only knew the provisions would be good law for all of 10 days during 2014, and we’ve spent the next 11-and-a-half months doing the same, “will they or won’t they?” dance. This is particularly problematic because these provisions are largely designed to compel taxpayers to act in a certain manner — for example, the R&D credit encourages innovation while the depreciation incentives motivate taxpayers to expand via capital improvements — and as a result, the uncertainty that surrounds their presence in the law effectively renders them useless.
As 2015 drew to a close, Congress was determined not to repeat its mistakes. After weeks of reports ranging from optimism for permanency to another one-year retroactive extender, a deal was in fact reached in the wee hours of December 16th, meaning if nothing else, Congress gave us a whopping five extra days of certainty for 2015 when compared to 2014.
So what makes this deal different? Let’s take a look at the impact.
Business Provisions Made Permanent
- R&D Credit: businesses, rejoice! The biggest ticket item of all the 52 extenders has finally been made permanent, as well as bigger and better. Beginning in 2016, businesses with less than $50 million in gross receipts will be free to use the credit to offset alternative minimum tax. In addition, certain start-up businesses who may not have an income tax liability will be able to offset payroll taxes with the credit.
- Enhanced Section 179 deductions: In recent years, taxpayers have been entitled to immediately deduct up to $500,000 of the cost of qualifying asset acquisitions (with a phase-out beginning at $2 million). These threshold were due to plummet to $25,000 and $200,000 respectively, beginning on January 1, 2015. The new deal retains Section 179 at the higher limits, while indexing them for inflation in future years. Taxpayers will continue to be eligible to apply Section 179 to purchases of computer software and qualified leasehold, retail, and restaurant improvements (see immediately below).
- Abbreviated 15-year life of qualified leasehold, retail and restaurant improvements: the shortened 15 — rather than 39 — year recovery life of these three types of assets has been made permanent.
- 100% exclusion on Section 1202 stock: changes made in 2009 and 2010 to Section 1202 — which allows a taxpayer who sells qualifying small business stock held for longer than 5 years to exclude part of the gain — increased the exclusion from 50% to 100% (subject to limitations). This 100% exclusion was made permanent for stock acquired after January 1, 2015, bringing great relief to investors who acquired QSBS stock in 2015.
- Reduction in S corporation built-in gains recognition period: While this change is unlikely to garner much press, it is extremely meaningful to owners of C corporations who have contemplated making an election to be taxed as an S corporation, as the corporation will now only be subject to corporate-level tax on the disposition of appreciated assets owned at the conversion date for five years, rather than the ten under previous law.
Individual Provisions Made Permanent
- Enhanced child tax credit: In addition to a $1,000 credit per qualifying child, since 2009 parents have been entitled to an additional refundable credit equal to 15% of earned income in excess of $3,000. Beginning in 2017, this threshold would have jumped back to $10,000; however, the lower threshold was made permanent as part of the deal, putting additional cash in the pockets of millions of Americans.
- Enhanced American opportunity tax credit: From 2009 through 2017, taxpayers have been entitled to a $2,500 credit for four years of post-secondary education, with phase-outs beginning at $80,000 (if single) and $160,000 (if married filing jointly). In 2017, however, the credit was slated to return to an $1,800 annual maximum with lower phase-out thresholds. This deal makes the enhanced credit a permanent fixture in the law.
- Enhanced earned income credit: Also slated to expire in 2017 were certain enhancements made to the earned income credit, a valuable, refundable incentive for low-income families. Today’s deal will make permanent the enhanced credit for families with three or more children and increased phase-out range for married couples filing jointly.
- Teachers will now be able to rest easy, knowing that each year they will be entitled to the generous $250 deduction for K-12 supplies. Even better, the deduction will finally be indexed for inflation.
- The itemized deduction for state and local sales taxes in lieu of income taxes were made permanent, as was the parity between employer-provided fringe benefits for employee parking and employer-provided fringe benefits for a mass transit parking pass.
- Charitable giving incentives: the bill permanently extends the following provisions encouraging charitable donations:
- deduction allowed for charitable contribution of real property for conservation purposes,
- taxpayers over 70 1/2 may make donations directly from an IRA and will not be taxed on the amounts (up to $100,000),
- a shareholder in an S corporation will be required to reduce his basis in the S corporation’s stock under Section 1366 only for his share of the basis of property contributed by the S corporation; not the fair market value.
Provisions Extended Through December 31, 2019
Not all of the 52 provisions were made permanent, however. The following were extended only through 2019:
- The new markets tax credit and bonus depreciation: the 50% immediate expensing of asset acquisitions that we’ve known in one form or another since 2001 is on its last legs. It will be permitted at 50% for 2015, 2016 and 2017 before reducing to 40% in 2018 and 30% in 2019, when it will then disappear altogether.
Provisions Extended Through December 31, 2016
The majority of the remaining 52 provisions were extended for two years, through December 31, 2016. Included among the two-year extenders are the following:
- Exclusion of COD income on principal residence: Since 2007, Section 108(a)(1)(E) has allowed a taxpayer who renegotiates the mortgage on his principal residence — or is forced to sell the home in a foreclosure or short sale that does not fully repay the lender, with the excess deficiency forgiven — to exclude up to $2 million of what would ordinarily be “cancellation of indebtedness” income under Section 61(a)(12).
- Tuition deduction: a maximum above-the-line deduction of $4,000 will continue to be permitted for tuition costs for higher education.
- Film and television productions: taxpayers will continue to be permitted to deduct the first $15 million of costs for qualified film, television and live theater productions.
- Energy incentives: the following energy incentives were extended for two years:
- A $500 credit for the purchase of certain non-business energy-efficient property,
- Up to a $2,000 credit available to the manufacturer of energy-efficient homes,
- Section 179D expensing of certain heating, cooling, and lighting improvements to commercial property.
Delay of Obamacare Provisions
Obamacare came under fire as part of the negotiations, as the agreement would pause the 2.3% excise tax on medical devices in 2016 and 2017, while the start of the so-called Cadillac tax on high-cost employer-sponsored health insurance would be delayed from 2018 to 2020.
Because the earned income credit is a lightning rod for fraud, taxpayers will not be permitted to file amended returns claiming the credit for a year when they did not have a valid social security number. The same holds true for the child tax credit; a taxpayer may not file an amended return claiming the credit for any year in which they did not have a valid ITIN (taxpayer identification number). In addition, taxpayers convicted of fraud in claiming the earned income credit will be barred from claiming the credit for ten years, while those found to have recklessly disregarded the rules will be prohibited from claiming the credit for two years. A 20% penalty will also be applied to the refundable portion of improperly claimed credits, reversing an earlier court decision.
The new deal also makes material changes to the treatment of tax-free spinoffs under Section 355 that involve a real estate investment trust, generally requiring that the spinoff will be tax-free only if immediately after the transaction, both the distributing and controlled corporations are REITs.
Foreign taxpayers selling an interest in US real property will be subject to a higher 15% withholding tax as opposed to the previous tax of 10%.
If you have any questions or would like to discuss this matter further, please contact a member of Withum’s National Tax Services Group by filling out the form below.