by  /  Tax Planning

As expected and discussed in previous submissions, Congress enacted the Tax Extender package prior to year-end 2015. President Obama signed the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act”), together with a FY 2016 Omnibus Budget, on December 18, 2015. This is much better news than expected, however, because PATH permanently renews many of the provisions, while renewing others for periods of a few years. For the first time in a number of years we will not find ourselves in tax limbo in late 2016, awaiting congressional action. As we commence our 2016 tax planning, we will focus on these legislative Christmas presents. This submission focuses on provisions affecting individual taxpayers, leaving corporate and partnership provisions for later submissions.

PERMANENT EXTENSIONS FOR INDIVIDUALS

  • State and Local Sales Tax Deduction—
    • Since 2004, taxpayers living in states without income tax (i.e., Florida, Texas, Nevada, South Dakota, Alaska, Washington and Wyoming) have had the ability to claim an itemized deduction for either the payment of state income taxes or state sales taxes. Since residents of these states paid no state income tax, this basically added a deduction for state sales tax—a huge benefit. This provision was renewed annually since 2004, until it was made permanent by PATH.
    • The state sales tax deduction can be determined by adding up the actual state sales tax paid (validated by receipts), or the IRS provides a sales tax deduction calculator that estimates what can be claimed as sales taxes based on the taxpayer’s income and zip code.
    • Typically, because state sales taxes apply only to goods that are purchased and state income taxes apply to all income, the latter is typically used, unless the taxpayer lives in a state with no income tax. Making this deduction permanent will clearly benefit taxpayers with low taxable income (retirees), who have large expenses, such as acquisition of cars or other large ticket items.
  • Qualified Charitable Distributions (“QCDs”) from IRAs—
    • Individuals age 70 ½ and older are now permanently allowed to make annual tax-free distributions of up to $100,000 directly from their IRAs to qualified charitable organizations, as they have been able to since 2006.
    • The contribution to the charity is not claimed as a tax deduction, but it is not included in income either, and therefore does not increase Adjusted Gross Income (“AGI”) for calculations such as Medicare surcharges or other taxes that are subject to AGI thresholds.
    • A QCD counts toward the taxpayer’s Required Minimum Distribution (“RMD”) obligation for those age 70 ½ or over.
    • This provision is clearly beneficial to charities and taxpayers, but taxpayers may still find donation of appreciated securities to be a more attractive alternative, due to avoidance of capital gains tax as well as a charitable deduction for the current fair market value of the donated stock.
  • Qualified Conservation Contributions—
    • The special rule allowing contributions of capital gain real property for conservation purposes, against an increased 50% of the contribution base and an extended carryforward period, is made permanent. 
  • Transit Benefits Parity—
    • Makes permanent the increase in the monthly exclusion for combined employer-provided transit passes and vanpool benefits to the same level as the monthly exclusion for employer-provided parking.
  • Enhanced American Opportunity Tax Credit (“OPPORTUNITY”)—
    • Previously, college students were eligible for a $1,800 Hope Scholarship Credit (“HOPE”) for tuition and related expenses in the first two years of college, with the less desirable Lifetime Learning Credit available in the last two years. HOPE phased out for joint filers with AGIs of $96,000.
    • In 2009, HOPE changed into the American Opportunity Tax Credit (“OPPORTUNITY”), expanding the credit to $2,500 per year, allowing it for up to four years of college, and raising the AGI phase-out to $160,000 for couples filing jointly.
    • OPPORTUNITY was scheduled to lapse and revert to Hope at the end of 2017.
    • OPPORTUNITY is now permanent.
  • Enhanced Child Tax Credit—
    • The child tax credit is a $1,000 credit available for each “qualifying child” living in the household (under 17, claimed as a dependent and provides half or less of his/her own support).
    • This phases out for joint filers with AGIs over $110,000.
    • Lower-income taxpayers, who did not have a $1,000 tax liability to credit against, received a refundable credit, called the additional child tax credit, for 15% of the earned income over a threshold. This amount would have been $14,000 today, but was reduced to $3,000 in 2009 until it was to go back to $14,000 + in 2017.
    • This $3,000 threshold was made permanent by PATH.
    • This allows many more lower-income taxpayers to receive the entire $1,000 additional child tax credit.
  • Earned Income Credit—
    • Makes permanent changes that were to disappear after 2017-
      • The $5,000 increase in the phase-out amount for joint filers, and
      • The increased 45 percent credit rate for taxpayers with three or more qualifying children.
  • Teachers’ Classroom Expense Deduction—
    • Permanently extends the above-the-line deduction for elementary and high school teachers’ classroom expenditures, including professional development expenses.
    • If teachers need not buy erasers, they might take some Continuing Education classes.

TWO-YEAR EXTENSIONS FOR INDIVIDUALS (THROUGH 2016)

  • Mortgage Debt Exclusion—
    • Traditionally when a taxpayer’s debt is discharged, other than due to total insolvency, the canceled debt is treated as taxable income.
    • The Mortgage Debt Relief Act of 2007 sought to provide relief for the declining real estate market by alleviating the traditional “cancellation–of-indebtedness income” rules for up to $2 million of cancelled debt associated with the mortgage on a primary residence.
    • Thus, a short sale of an “underwater” residence does not result in income for the difference between the value realized and the mortgage balance for a primary residence. This permitted the taxpayers who just took a loss on their house to avoid paying tax on the “income” represented by the loss below the mortgage amount.
    • This represented an important benefit to unfortunate homeowners, and is extended through 2016. Those facing a short sale of their principal residence below their mortgage amount may wish to consider such a sale (or at least entering into a binding written agreement to do so) in 2016, in case this provision is not extended again.
  • Mortgage Insurance Premium Deduction—
    • For taxpayers who pay Private Mortgage Insurance (PMI) for a mortgage that had a less-than-20% down payment, current law allows a deduction for the mortgage insurance payment, as interest on mortgage debt, as long as the mortgage was incurred after 2006 on a primary residence.
    • This phases out for joint AGIs above $110,000.
  • Above-the-Line Education Deduction for Tuition and Fees—
    • An alternative to the OPPORTUNITY or the Lifetime Learning Credit for college expenses discussed above, is to claim the “above-the-line deduction” of up to $4,000 of tuition and related fees for a dependent college student.
    • This dropped to $2,000 for joint AGIs of $130,000 and was eliminated for joint AGIs of $160,000.
    • This is generally a less desirable outcome to the OPPORTUITY credit of $2,500.

A review of these Extenders confirms that many of them were “gifts” to certain taxpayers that were deemed worthy. It is fortunate from a planning viewpoint, therefore, that many of these benefits of social engineering through the tax code were made permanent, so as to no longer be subject to an annual judgment of their worth. After all, who can deny that Teachers buying chalk and erasers out of their own pockets should be entitled to a $250 deduction?

 

Remember, it’s not what you make that matters…it’s what you keep!



Disclaimer

The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties.  Please seek advice from an independent tax advisor before acting on any information presented.