Generous tax extenders package enacted, with many provisions made permanent
R&D credit and equipment expensing provisions made permanent
TAX ALERT |
The Internal Revenue Code contains over 50 temporary credits, deductions and other beneficial provisions that expire periodically and must be extended by Congress in order to remain in effect. Consequently, many tax breaks that expired at the end of 2014 were the subject of intense negotiations in the House and the Senate over the past several weeks. At issue was the effort by Republicans to make certain popular business incentives permanent (notably, the research tax credit and enhanced section 179 expensing limits) and the counter effort by Democrats to make certain provisions that benefit working families permanent (notably, the earned income tax credit, child tax credit and American opportunity tax credit). Congressional leaders were able to negotiate an agreement that met both of these goals. The Protecting Americans from Tax Hikes Act of 2015 retroactively extends and makes permanent many of the expiring provisions. Further, the legislation retroactively extends to the beginning of 2015 and through the end of 2016 (or later) most of the remaining provisions that were not made permanent. In addition, the legislation makes some other significant changes to the tax laws including provisions affecting real estate investment trusts (REITs) and foreign investments in real estate.
The legislation was signed into law by the president on Friday, Dec. 18, 2015. The discussion that follows highlights the extended tax provisions, and some new permanent provisions, that are most relevant to leaders and owners of middle market businesses:
Business tax extenders and new permanent provisions
Permanent extensions and new permanent provisions
Research and development tax credit. The research and development (R&D) tax credit is modified and made permanent. Eligible small businesses ($50 million or less in gross receipts) may now claim the credit against alternative minimum tax (AMT). Additionally, a small business start-up is now able to claim a credit of up to $250,000 against its FICA payroll tax liability if it had less than $5 million in gross receipts for the current taxable year and no gross receipts for any taxable year prior to the five-taxable-year period ending with the current taxable year.
Small business expensing. The section 179 limitation and phase-out amounts are permanently set at $500,000 and $2 million, respectively, and indexed for inflation. Eligible property includes computer software, qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.
15-year recovery period for certain property. Qualified leasehold improvements, qualified restaurant property, and qualified retail improvements are now permanently eligible for a 15-year recovery period.
Exception from subpart F income for active financing income. The active financing exception is made permanent, allowing multinational financial companies to defer U.S. income tax on income from certain active banking, financing, insurance or similar business activities.
Exclusion of gain on certain small business stock. The provision allowing for exclusion of 100 percent of the gain on certain small business stock for non-corporate taxpayers, if held for more than five years, has been made permanent. This provision also eliminates such gain as an AMT preference item.
Stock basis adjustments for S corporations making charitable contributions of property. The provision allowing an S corporation shareholder’s stock basis to be reduced by his or her pro rata share of the adjusted basis of property contributed by the S corporation for charitable purposes rather than the amount of the allocable charitable deduction was also made permanent.
Five-year built-in gains period for S corporations. The provision exempting an S corporation from corporate tax on the built-in gain on assets held at the time of a conversion from C corporation status, if the assets are held for five years after the conversion, is made permanent. The previous requirement was to hold such assets for 10 years.
Low income housing tax credit. The 9 percent minimum credit rate was made permanent for non-federally subsided new buildings, and the calculation excludes military basic housing allowances from the calculation of income for determining an eligible tenant for the credit.
Increase in rate of withholding of tax on dispositions of U. S. real property interests. In a new permanent provision, the rate of withholding on dispositions of U.S. real property interests is increased from 10 percent to 15 percent. The increased rate of withholding, however, does not apply to the sale of a personal residence where the amount realized is $1 million or less. The provision is effective for dispositions occurring 60 days after the date of enactment.
Liberalize rules governing foreign investment in real estate. In a series of new permanent provisions, several changes are included that will be welcomed by the real estate industry, such as an increase in the amount that many foreign persons can invest in REITs without triggering U.S. taxation under the Foreign Investment in Real Property Tax Act (FIRPTA). A discussion of FIRPTA can be found in our article, FIRPTA rules impact U.S. real estate transactions.
Curb certain REIT transactions. In a new permanent provision, the legislation prohibits a strategy known as a REIT spin-off, which had previously been used and was currently contemplated by many multinational corporations. That strategy, discussed in detail in our 2014 article, Spin-offs followed by REIT conversions are becoming increasingly popular, had drawn the ire of many in Congress, and this provision prohibits such transactions in the future.
Changes to related-party loss rules for “tax-indifferent” parties. In a new permanent provision, the current related-party loss rules are modified to prevent losses from being shifted from a party that is not subject to tax (such as a foreign person or corporation) to a U.S. taxpayer. Previously, a related-party buyer had the ability to deduct losses that were disallowed for the related seller when that asset was ultimately sold to a third party. This provision removes the ability of the related-party buyer to deduct that loss if the related-party seller would not have received a tax benefit from the loss on the original sale.
Provisions extended through 2019 and beyond
50-percent bonus depreciation. Fifty-percent bonus depreciation is now available for qualified property, including qualified improvement property, acquired and placed in service during calendar 2015, 2016 and 2017, with a deduction for 40 percent of the cost of eligible property available in calendar 2018 and a 30 percent deduction available in calendar 2019. The provision also extends the election to accelerate the use of AMT credits in lieu of bonus depreciation and increase the amount of unused AMT credits that may be claimed in lieu of bonus depreciation.
Look-through treatment for payments of dividends, interest, rents and royalties between related controlled foreign corporations. The ability to defer U.S. tax liability on passive interest, rents and royalties of a foreign subsidiary has been extended through 2019.
Work Opportunity Tax Credit. The legislation extends and modifies the Work Opportunity Tax Credit through 2019. The credit is modified to apply to employers that hire qualified long-term unemployed individuals and is increased for those individuals to 40 percent of the first $6,000 of wages. A qualified long-term unemployed individual is someone who has been unemployed for 27 weeks or more.
Extension of solar investment credits. The 30 percent investment tax credit for qualified solar property is fully extended through 2019, with a 26 percent credit available in 2020 and a 22 percent credit available in 2021.
Extension of wind production and investment credits. The production tax credit and election to claim investment tax credit related to qualified wind property are phased out over five years, with full credit for 2015 and 2016, 80 percent for 2017, 60 percent for 2018, and 40 percent for 2019.
New markets tax credit. The legislation authorizes an additional $3.5 billion of credit allocations in each year from 2015 to 2019.
Provisions extended through 2016
Empowerment zones. Tax benefits for certain businesses and employers operating in empowerment zones are extended through 2016. The incentive is modified by allowing employees to meet the enterprise zone facility bond employment requirement if they reside in the empowerment zone, an enterprise community, or a qualified low-income community within an applicable nominating jurisdiction.
Energy tax extenders. The legislation extends through 2016 several energy incentive provisions, including:
- The section 45 production tax credit and election of the investment tax credit for certain renewable energy sources other than wind for facilities on which construction begins before 2017.
- The section 179D deduction for energy efficient improvements to lighting, heating, cooling, ventilation and hot water systems for commercial buildings. The legislation also updates the ASHRAE standards to be applied to measure energy efficiency.
- The $0.50 per gallon alternative fuel tax credit and the alternative fuel mixture tax credit. This provision also updates the equivalency rates for liquefied natural gas ($0.29 per gallon) and liquefied petroleum gas ($0.36 per gallon), effectively reducing the credits available to users of liquefied natural gas or liquefied petroleum gas.
- The $1 per gallon biodiesel and renewable diesel credit.
- The section 30C alternative fuel vehicle refueling property credit, allowing for a credit of up to 30 percent of installation costs.
- The section 45L new energy efficient homes credit in the amount of $1,000 or $2,000 per unit.
- The credit for new qualified fuel cell motor vehicles. The legislation allows a credit of between $4,000 and $40,000, depending on the weight of the vehicle, for the purchase of such vehicles.
Provision suspended for 2016 and 2017
Medical device excise tax. The legislation puts a two-year moratorium on the 2.3 percent excise tax on the sale of manufactured medical devices. The tax will not be due on sales of medical devices in calendar 2016 and 2017.
Provision suspended for 2018 and 2019
Delay of “Cadillac Tax” on certain health plans. The effective date for the excise tax applicable to high-value health insurance plans is postponed for two years, from 2018 to 2020.
Individual, non-business provisions
Although much of the focus has been on the extension of business tax extenders, there are several individual tax extenders, and a few new permanent tax provisions, that will have a material impact on individual taxpayers.
Permanent extensions and new permanent provisions
Deduction of state and local general sales taxes. The option to take an itemized deduction for state and local general sales taxes in lieu of an itemized deduction for state and local income taxes is made permanent.
Tax-free distributions from individual retirement plan for charitable purposes. The legislation permanently extends the provision allowing an Individual Retirement Account (IRA) owner who is age 70-1/2 or older to exclude from adjusted gross income (AGI), in 2015 and all future tax years, up to $100,000 per year in distributions made directly from the IRA to certain public charities.
Child tax credits and earned income tax credits. Enhanced credits for low and moderate income parents and workers have been permanently extended and indexed for inflation.
American opportunity tuition credits. Increased credits for various tuition and related expenses are made permanent and indexed for inflation. For 2015, this credit is capped at $2,500 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers).
Deduction for certain expenses of elementary and secondary school teachers. There is a permanent extension and indexing for inflation of the provision allowing elementary and secondary school teachers to take an above-the-line deduction (capped at $250) for eligible expenses, including certain professional development expenses.
Parity for exclusion from income for employer-provided mass transit and parking benefits. Transit passes and vanpool benefits are now permanently excluded from an employee’s wages for payroll tax purposes and from gross income for income tax purposes at the same amount as employer-provided parking.
Contributions of capital gain real property made for conservation purposes. There is now a permanent extension of the provisions allowing, in lieu of the 30 percent of AGI limit otherwise imposed on charitable contributions of capital gain property, a higher limit of 50 percent of AGI, with the ability to carry forward the deduction for a period of 15 years. The provision also allows certain individual and corporate farmers and ranchers to deduct donations of real property for conservation purposes in an amount up to 100 percent of the taxpayer’s AGI.
Rollovers to SIMPLE-IRA now permitted. In a new permanent provision, employees who have been participating in a SIMPLE-IRA for at least two years are now able to roll over distributions from other qualified plans (e.g., a former employer’s 401(k) plan).
Church retirement plans. In a new permanent provision, church plan sponsors have received relief from some of the rules regarding nondiscrimination in contribution and benefits, as well as favorable enhancements to plan administration (e.g., permitting automatic enrollment).
Provisions extended through 2016
Extension and modification of mortgage debt relief. Taxpayers can continue to exclude up to $2 million of forgiven debt ($1 million if married filing separately) through the 2016 tax year. However, this debt forgiveness has to be directly related to a decline in the home’s value or attributable to the taxpayer’s financial condition.
Extension of mortgage insurance premiums treated as qualified residence interest. The legislation extends through 2016 the treatment of qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. This provision is specifically earmarked for middle-class taxpayers since this deduction phases out ratably for taxpayers with adjusted gross income of $100,000 to $110,000.
Extension of above-the-line deduction for qualified tuition and related expenses. The legislation extends through 2016 the above-the-line deduction for qualified tuition and related expenses for higher education. This deduction is capped at $4,000 for an individual whose AGI does not exceed $65,000 ($130,000 for joint filers) or $2,000 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers).
IRS and Tax Court reforms
Reforms to protect taxpayers
Several reforms included in the legislation address issues involving Tax Court litigation and the IRS’s administration of the Internal Revenue laws. These include clarifying the circumstances where an IRS employee can be terminated for taking official action for political purposes and providing that IRS employees and officers are not permitted to use personal email accounts for official business.
Procedural changes related to non-profit organizations
The new legislation also imposes several procedural changes relating to IRS consideration of certain issues of concern to non-profit organizations under section 501(c).
In order to safeguard taxpayer information and prevent identity theft, the legislation grants the authority to the IRS to require truncated Social Security numbers on Form W-2.
This new and improved extenders legislation is a significant holiday present for many businesses and business owners since it removes the uncertainty surrounding several of the most popular business tax incentives. This should greatly improve the effectiveness of these incentives, drive increased investment and innovation, and create jobs.
Some additional planning ideas to consider as 2015 comes to a close:
- Place assets in service before year end, especially if eligible for section 179 expensing or bonus depreciation
- Make charitable contributions, particularly from an IRA now that the relevant rules have been extended
- Ensure that proper documentation and certification exists for Work Opportunity Tax Credits
- Ensure that proper documentation exists for R&D tax credits
- Consider year-end changes in partnership or limited liability company structures, allocations or agreements that may affect tax issues for 2015 or 2016
- Consider reforming or rescinding any 2015 transactions that may qualify for rules allowing them to be reformed or rescinded within the same taxable year