On the morning of Dec. 18, the U.S. House of Representatives passed a $1.1 trillion spending bill and accompanying legislative package of tax extenders (the “Protecting Americans from Tax Hikes (PATH) Act of 2015”) by a vote of 316 to 113. A short time later, the U.S. Senate voted 56 to 33 in favor of the legislation. Late that same day, President Obama signed the spending bill into law.
The Joint Committee on Taxation estimates that the total cost of the tax provisions in the bill will be $622 billion over 10 years—the tax extenders are estimated to cost $629 billion, and the changes to tax administration and other revenue-raisers are estimated to bring the cost down to $622 billion.
TAX CHANGES FOR INDIVIDUALS
Enhanced Child Tax Credit Made Permanent
Section 24 allows taxpayers to claim a $1,000 tax credit for each qualifying child under age 17 that the taxpayer can claim as a dependent (the “Child Tax Credit” or “CTC”). The CTC phases out when taxpayers’ income exceeds certain thresholds. To the extent the CTC exceeds the taxpayer’s tax liability, the taxpayer is eligible for a refundable credit equal to 15% percent of earned income in excess of a threshold dollar amount.
The PATH Act makes the enhanced CTC permanent by setting the threshold dollar amount for purposes of computing the refundable credit at an unindexed $3,000. This change is effective for tax years beginning after the date of enactment.
Program integrity provisions. Also included in the PATH Act are “program integrity” checks for the CTC, as well as other credits (described below) designed to reduce improper payments, including:
- Prohibiting individuals from retroactively claiming the CTC by amending a return;
- Extending the paid-preparer due diligence penalty; and
- Barring individuals convicted of fraud or intentional disregard of tax rules from claiming the CTC
Enhanced American Opportunity Tax Credit (AOTC) Made Permanent
The PATH Act makes the AOTC permanent, at an amount of $2,500 for four years of post-secondary education, with the beginning of the phase-out amount at $80,000 (single) and $160,000 (married filing jointly).
Program integrity provisions. In addition to the above provisions, a taxpayer claiming the AOTC must report the employer identification number (EIN) of the educational institution to which the taxpayer makes qualified payments under the credit. Higher education institutions are required to report (on Form 1098-T) only qualified tuition and related expenses actually paid (rather than choosing between amounts paid and amounts billed, as under current law).
Enhanced Earned Income Tax Credit Made Permanent
The enhanced EITC amount of 45% for those with three or more children has been made permanent, and the EITC marriage penalty has been reduced by increasing the income phase-out range by $5,000 (indexed for inflation) for those who are married and filing jointly.
Eligible elementary and secondary school teachers could, for tax years beginning before Jan. 1, 2015, claim an above-the-line deduction for up to $250 per year of expenses paid or incurred for books, certain supplies, computer and other equipment, and supplementary materials used in the classroom. The PATH Act permanently extends the educator expense deduction and, for tax years beginning after Dec. 31, 2015, modifies the deduction by (i) indexing the $250 amount for inflation, and (ii) treating professional development expenses as expenses eligible for the deduction.
Above-the-Line Deduction for Higher Education Expenses Retroactively Extended Through 2016
Effective for tax years beginning after Dec. 31, 2014, the PATH Act creates a permanent deduction for eligible individuals to deduct “qualified tuition and related expenses” of the taxpayer, his spouse, or dependents as an adjustment to gross income to arrive at AGI. The maximum deduction is $4,000 for individuals whose AGI for the tax year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for individuals whose AGI doesn’t exceed $80,000 ($160,000 in the case of a joint return).
Exclusion for Discharged Home Mortgage Debt Retroactively Extended Through 2016
The PATH Act extends for two years the exclusion of discharge of indebtedness income from qualified principal residence debt, up to a $2 million limit ($1 million for married individuals filing separately), so that it applies to home mortgage debt discharged before Jan. 1, 2017. According to an official summary of the bill, the exclusion applies to qualified principal residence debt that is discharged in 2017, if the discharge is pursuant to a binding written agreement entered into in 2016.
Mortgage Insurance Premiums as Deductible Qualified Residence Interest Retroactively Extended Through 2016
Effective for amounts paid or accrued after Dec. 31, 2014, The PATH Act retroactively extends for two years the deduction for mortgage insurance premiums paid or accrued by a taxpayer in connection with acquisition indebtedness on a qualified residence, so that it applies to premiums paid or accrued before Jan. 1, 2017. The deduction is phased out ratably by 10% for each $1,000 by which the taxpayer’s AGI exceeds $100,000 ($500 and $50,000, respectively, in the case of a married individual filing a separate return).
The PATH Act also:
- Permanently extends the maximum monthly exclusion amount for transit passes and van pool benefits so that these transportation benefits match the exclusion for qualified parking benefits for months after Dec. 31, 2014.
- Retroactively revives and makes permanent the option to claim an itemized deduction for State and local general sales taxes in lieu of an itemized deduction for State and local income taxes for tax years beginning after 2014.
- Retroactively revives and permanently extends the charitable deduction for contributions of real property for conservation purposes and the enhanced deduction for certain individual and corporate farmers and ranchers for months after Dec. 31, 2014.
- Retroactively revives and permanently extends the ability of individuals at least 70½ years of age to exclude from gross income qualified charitable distributions from IRAs of up to $100,000 per year, effective for distributions made in tax years beginning after Dec. 31, 2014.
Health Care Provisions
- The so-called “Cadillac tax” on high-cost health coverage, imposed by Sec. 4980I, is delayed for two years and is now effective for tax years beginning after Dec. 31, 2019. The provision imposes a 40% nondeductible excise tax on the amount by which the monthly cost of an employee’s “applicable employer-sponsored coverage” exceeds statutory dollar limits.
- The PATH Act also delays the 2.3% medical device excise tax under Sec. 4191, which will now not apply to sales during 2016 and 2017.
- The PATH Act also puts a one-year moratorium on the Patient Protection and Affordable Care Act’s annual fee on health insurance providers, which applies to any covered entity engaged in the business of providing health insurance for U.S. health risks.
TAX CHANGES FOR BUSINESSES
Research Credit Permanently Extended and Made Creditable Against Other Taxes
Section 41 permits a research credit equal to the sum of: (1) 20% of the excess (if any) of the qualified research expenses for the tax year over a base amount (unless the taxpayer elected an alternative simplified research credit); (2) the university basic research credit (i.e., 20% of the basic research payments); and (3) 20% of the taxpayer’s expenditures on qualified energy research undertaken by an energy research consortium.
The PATH Act retroactively and permanently extends the research credit. In addition, for tax years that begin after Dec. 31, 2015, eligible small businesses ($50 million or less of gross receipts) may claim the credit against their alternative minimum tax (AMT) liability. And, for tax years that begin after Dec. 31, 2015, small (less than $5 million of gross receipts) startup businesses may claim up to $250,000 per year of the credit against their employer FICA tax liability.
Reduction in S Corp Recognition Period for Built-In Gains Tax Permanently Extended
Where a corporation that was formed as a C corporation elects to become an S corporation, the S corporation is taxed at the highest corporate rate on all gains that were built-in at the time of the election if the gain is recognized during a recognition period. The PATH Act retroactively and permanently provides that, for determining the net recognized built-in gain, the recognition period is a 5-year period.
Exclusion of 100% of Gain on Certain Small Business Stock Permanently Extended
The PATH Act retroactively and permanently extends the 100% exclusion of gain on the disposition of qualified small business stock acquired after Sept. 27, 2010 and before Jan. 1, 2015. None of the excluded gain is subject to the alternative minimum tax.
DEPRECIATION AND EXPENSING
Enhanced Sec. 179 Expensing Made Permanent
The PATH Act makes several changes to the Sec. 179 expensing election, including:
- The $500,000 expensing limitation and $2 million phase-out amounts are retroactively extended and made permanent and indexed for inflation.
- The rule that allows expensing for computer software is retroactively extended and made permanent.
- The ability to revoke a Sec. 179 election without IRS consent is made permanent.
- For tax years beginning after Dec. 31, 2015, expensing of qualified real property is made permanent without a carryover limitation, and the $250,000 expensing limitation with respect to qualifying real property is eliminated.
- For tax years beginning after Dec. 31, 2015, air conditioning and heating units are eligible for expensing.
15-Year Writeoff for Qualified Leasehold and Retail Improvements and Restaurant Property Made Permanent
Effective for property placed in service after Dec. 31, 2014, The PATH Act retroactively extends and makes permanent the inclusion of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property in the 15-year MACRS class.
Bonus First-Year Depreciation Extended Through 2019
The PATH Act extends additional first-year depreciation deduction (also called bonus first-year depreciation) equal to 50% of the adjusted basis of qualified property acquired and placed in service during 2015 through 2019 (through 2020 for certain longer-lived and transportation property). Eligible taxpayers will be able to claim:
(1) a 50% bonus depreciation allowance for qualified property placed in service in 2015 through 2017 ;
(2) a 40% bonus depreciation allowance for qualified property placed in service in 2018; and
(3) a 30% bonus depreciation allowance for qualified property placed in service in 2019.
The PATH Act also provides that:
- After 2015, additional first-year depreciation is allowed for qualified improvement property without regard to whether the improvements are property subject to a lease, and there is no requirement that the improvement must be placed in service more than three years after the date the building was first placed in service.
- The special rule for the allocation of bonus depreciation to a long-term contract is extended for five years to property placed in service before Jan. 1, 2020.
- For property placed in service during 2015, The PATH Act allows taxpayers to elect to accelerate the use of AMT credits in lieu of bonus depreciation under special rules. Beginning in 2016, The PATH Act modifies the AMT rules by increasing the amount of unused AMT credits that may be claimed in lieu of bonus depreciation.
Enhanced First-Year Depreciation Cap for Autos and Trucks Extended Through 2019
Depreciation deductions that can be claimed for passenger autos are subject to dollar limits that are annually adjusted for inflation. For passenger automobiles placed in service in 2015, the adjusted first-year limit is $3,160. For light trucks or vans, the adjusted first-year limit is $3,460.
The PATH Act increases the limitation for a passenger auto or light truck or van that is qualified property:
- By $8,000, if placed in service before 2018;
- By $6,400, if placed in service in 2018; and
- By $4,800, if placed in service in 2019.
Amount of penalty: The PATH Act amends the Sec. 6664(a) definition of “underpayment” to include the refundable portion of credits, overruling the Tax Court’s decision in Rand, 141 T.C. 376 (2013), which held that the amount of tax shown on the taxpayers’ return was reduced by refundable credits, but not below zero, for purposes of calculating the Sec. 6662(a) accuracy-related penalty.
Erroneous refunds and credits: The PATH Act also repeals the Sec. 6676 exception from the penalty for erroneous refunds and credits that currently applies to the earned income tax credit (EITC) and provides reasonable-cause relief from the penalty.
Paid tax return preparers: The penalty imposed on paid tax return preparers who engage in willful or reckless conduct is increased to the greater of $5,000 or 75% of the preparer’s income with respect to the return.
Information returns: The PATH Act requires Forms W-2, Wage and Tax Statement, and W-3, Transmittal of Wage and Tax Statements, and returns or statements that report nonemployee compensation (such as Form 1099-MISC, Miscellaneous Income) to be filed by Jan. 31 of the year following the calendar year to which the return relates. Those returns are no longer eligible for the extended filing date for electronically filed returns. This provision is effective for returns and statements filed in 2017.
The PATH Act also establishes a safe harbor from penalties for failure to file correct information statements and from failure to furnish correct payee statements. Under the safe harbor, if an error is $100 or less ($25 in the case of errors involving tax withholding) the issuer is not required to file a corrected return and no penalty will be imposed. The recipient, however, can elect to have a corrected return issued. This provision applies to returns and statements required to be filed after Dec. 31, 2016.
ITINs: The PATH Act provides that the IRS may issue ITINs if the applicant provides the documentation required by IRS either (a) in person to an IRS employee or to a community-based certified acceptance agent (as authorized by IRS), or (b) by mail. Individuals who were issued ITINs before 2013 are required to renew their ITINs on a staggered schedule between 2017 and 2020. An ITIN will expire if an individual fails to file a tax return for three consecutive years. These provisions are effective for requests for ITINs made after the date of enactment.
Due-diligence requirements: The PATH Act expands the due-diligence requirements for paid tax return preparers to include returns that claim the child tax credit and/or the American opportunity tax credit. This provision is effective for tax years beginning after Dec. 31, 2015.
Higher education information reporting: The PATH Act changes the Form 1098-T, Tuition Statement, reporting requirements, so that schools will be required to report only qualified tuition and related expenses actually paid. This provision is effective for expenses paid after Dec. 31, 2015, for education furnished in academic periods starting after that date.
Sec. 529 accounts: The PATH Act expands the definition of qualified higher education expenses that are eligible for tax-preferred distributions from Sec. 529 accounts to include computer technology and equipment. The Sec. 529 account rules are modified to eliminate the distribution aggregation requirements, so any distribution from a 529 account will be treated as coming only from that account, even if the individual making the distribution has more than one 529 account. The PATH Act also treats a refund of tuition that was paid with amounts distributed from a 529 account as a qualified expense if the amount is recontributed to a 529 account within 60 days. The provision is effective for distributions made or refunds after 2014, or, in the case of refunds after 2014 and before the date of enactment, for refunds recontributed not later than 60 days after the date of enactment.
ABLE accounts: The PATH Act allows individuals to establish ABLE accounts (tax-deferred accounts for individuals with disabilities) in any state. Previously, individuals could set up accounts only in their state of residence. This change is effective for tax years beginning after Dec. 31, 2014.
Rollovers into SIMPLE IRAs: The PATH Act allows taxpayers to roll over amounts from employer-sponsored retirement plans to a SIMPLE IRA, for contributions after the date of enactment.
Taxpayer rights: The PATH Act requires the IRS to ensure that its employees are familiar with and act in accord with certain taxpayer rights:
- The right to be informed;
- The right to quality services;
- The right to pay no more than the correct amount of tax;
- The right to challenge the IRS’s position and be heard;
- The right to appeal the IRS’s decisions in an independent forum;
- The right to finality;
- The right to privacy;
- The right to confidentiality;
- The right to retain representation; and
- The right to a fair and just tax system.
Email accounts: The PATH Act also prohibits IRS employees from using personal email accounts to conduct official business.
Sec. 501(c)(4) status: New Sec. 506 requires organizations that intend to operate as social welfare organizations under Sec. 501(c)(4) to notify the IRS within 60 days of the organization’s establishment. The notice must include a statement of purpose for the organization. The IRS must then provide an acknowledgment of receipt within 60 days of receiving the notice. Such organizations may also request a tax-exempt determination from the IRS. The IRS can also require certain information from the organization on its first return. Failure to submit the notice can result in a fine of up to $5,000.
Political actions by IRS employees: The PATH Act requires the termination of any IRS employee who performs, delays, or fails to perform official actions for political purposes.
Truncated Social Security numbers: The PATH Act requires employers to include an “identifying number” for each employee, rather than the employee’s Social Security number on Form W-2. This will allow Treasury to issue regulations permitting use of a truncated Social Security number on Form W-2. The AICPA has long advocated for this measure to help prevent identity theft.
TAX COURT RULES
Federal Rules of Evidence: The PATH Act requires the Federal Rules of Evidence to be used in Tax Court cases, rather than the rules of evidence applicable in trials without a jury in the U.S. District Court of the District of Columbia.
Interest Abatement: The PATH Act changes the filing period for interest abatement cases filed in the Tax Court and makes them eligible to be heard under the small tax case procedures if the abatement sought does not exceed $50,000.
Spousal Relief Cases: The PATH Act changes the venue for appeals of spousal relief and collection cases. It also suspends the running of the period for filing a petition for spousal relief or for filing a petition in a collection case where there is a pending bankruptcy case.
Article I Court: The PATH Act also clarifies in Sec. 7441 that “The Tax Court is not an agency of, and shall be independent of, the executive branch of the Government.” (The Tax Court was established as an Article I (legislative) court by the Tax Reform Act of 1969; before that it was an independent agency of the executive branch performing a judicial function)
Daniel L. Mellor is an associate with the form. He earned his J.D. at the George Mason University School of Law in Arlington, VA and his Masters of Laws (LL.M.) in Taxation from the Temple University School of Law in Philadelphia, PA. Mr. Mellor serves on the Executive Committee of the New Jersey State Bar Association, Young Lawyers Division, as the Liaison to the Tax Law Section. Mr. Mellor’s particular areas of expertise include business transactions, estate planning, and probate litigation.