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Emergency Economic Stabilization Act of 2008: Effect on Individual Tax Returns

By Nancy Faussett, CPA
Publication date: 10/07/2008

The legislation, signed into law on October 3, 2008, actually contains three separate acts: the Emergency Economic Stabilization Act of 2008; the Energy Improvement and Extension Act of 2008; and the Tax Extenders and Alternative Minimum Tax Relief Act of 2008. While the main focus of this Act was to address the recent financial crisis, it ended up including $150 billion in tax incentives for both individuals and businesses.

This article will look at some of the principal provisions of the Act, including tax extenders, energy incentives, and disaster relief as they affect personal income tax returns. This article will focus on those individuals who are not also small business owners.

AMT Patch

The Act increases the 2008 AMT exemption for individuals from $33,750 to $46,200, for married filing jointly the exemption is increased from $45,000 to $69,950, and for those married taxpayers filing separately the exemption is increased from $22,500 to $34,975. Furthermore, nonrefundable personal credits may be used to offset the AMT. Once again, this is only a “patch” to the AMT problem as it is temporary. If further legislation is not passed, the AMT exemption amounts will return to their 2000 levels in 2009.

Incentive Stock Options (ISOs) and Minimum Tax Credit

Although ISOs are not taxed for regular tax purposes upon exercise, under AMT, the value of the stock is taxed when the option is exercised. However, many individuals exercised their ISOs, before the current economic downturn, when the stocks’ value was very high. Since that time, most stock prices have plummeted. The Act will abate the AMT liability caused by the exercise of incentive stock options before 2008 and any underpayment of tax, including penalties and interest will also be abated. Furthermore, the Act allows taxpayers to accelerate the refund of the minimum tax credit and increases the minimum tax credit by 50% of any interest and penalties paid before October 3, 2008 due to the AMT adjustment for ISOs. (This will be allowed for the first two years beginning after December 31, 2007.)

Tax Extenders

The Act extends the following credits, deductions, and various rules that were about to expire:

• Deduction for State and Local General Sales Taxes: The Act has a provision that extends for two years, through 2009, the right of individuals to claim an itemized deduction for state and local general sales taxes in lieu of claiming an itemized deduction for state and local income taxes.
• Deduction for Qualified Tuition and Related Expenses: There is an above-the-line deduction allowed for qualified tuition and related expenses for higher education purposes. Taxpayers with AGI of $80,000 ($160,000 for a joint return) or less may deduct up to $2,000 and those whose AGI does not exceed $65,000 ($130,000 for a joint return) may deduct up to $4,000. This deduction is extended for two years, through 2009.
• Deduction for Certain Expenses of Elementary and Secondary School Teachers: There is an above-the-line deduction allowed for qualified educational expenses of teachers, up to $250. This deduction is extended for two years, through 2009.
• Additional Standard Deduction for Real Property Taxes for Non-itemizers: Taxpayers who claim the standard deduction and do not itemize, may claim an additional standard deduction for real property taxes paid, up to $500 ($1,000 for a joint return). This deduction is extended for one year, through 2009.
• Tax-Free IRA Transfers to Eligible Charities: There is a $100,000 exclusion from gross income for certain charitable contributions made from an IRA, or Roth IRA, by individuals who are 70 ½ or older. This provision is extended for two years, through 2009.
• Certain Rules for RICs: There are several provisions for Regulated Investment Companies (RICs) that are extended by this Act:

• Treatment of Interest-Related Dividends: An RIC may designate certain dividends as “interest-related dividends” by sending its shareholders written notices not more than 60 days after the end of its tax year. The Act extends the treatment of such dividends for tax years of an RIC beginning before January 1, 2010.
• Estates of Nonresidents who are not Citizens: There is an estate tax look-through rule for certain RIC stock held by nonresidents who are not citizens. While generally stock of a domestic corporation is treated as property within the U.S., current law allows a portion of RIC stock owned by a nonresident who is not a citizen to be treated as property not within the U.S. The Act extends this provision for estates of decedents dying before January 1, 2010.
• RICs as “Qualified Investment Entities: The Act extends the inclusion of a RIC within the definition of a “qualified investment entity” under IRS Code Section 897 through 2009.

Child Tax Credit

Currently there is a $1,000 tax credit for each qualifying child under the age of 17. When the credit is more than the amount of the taxpayer’s tax liability, a refund may be issued if the income threshold is met. The Act lowers the refundable threshold to $8,500 (it was $12,050) for 2008.

Modification of Penalty on Understatement of Income Tax Liability by Tax Preparer

For tax returns prepared after May 25, 2007, the Act modifies the standards for imposing the tax return preparer penalty. The standard for an undisclosed position is reduced to “substantial authority.” The standard for disclosed positions is “reasonable basis.”

Tax Relief for Midwest Disaster Victims

The Act provides tax relief for victims of the Midwestern disasters in Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska and Wisconsin. These proposals apply to taxpayers affected by floods, severe storms, and tornadoes that occurred in these states and that were declared to be major disaster areas by the President on or after May 20, 2008, and before August 1, 2008. There are two categories of relief given to these taxpayers: the first is for taxpayers located in all counties of these ten states and the other category is for the victims in the hardest hit areas in these ten states.

CATEGORY 1: RELIEF FOR ALL COUNTIES DECLARED ELIGIBLE FOR ASSISTANCE

• Waiver of Premature Distribution Penalty: The Act waives the 10% withdrawal penalty assessed on distributions from an IRA or tax-favored retirement plan (such as a 401(k) plan) made before attaining the age of 59 ½. The distribution cannot exceed $100,000 and must be made before January 1, 2010.
• Recontribution of Withdrawals for Home Purchases: The Act allows a distribution from an IRA, a 401(k) plan, or a 403(b) plan that was made for a home purchase, six months before the disaster’s declaration date but that was not finalized due to the disaster, to be recontributed tax free. This must be done within five months from October 3, 2008.
• Loans from Qualified Plans:The Act doubles the amount of allowable loans from a 401(k), 403(b), or 457(b) plan by a participant who sustained an economic loss from the disaster. The allowable loan amount is the lesser of $100,000 or 100% of the vested accrued benefit for loans made on or after October 3, 2008 and before January 1, 2010.
• Suspension of Casualty Loss Limitations: The Act eliminates the $100 floor and the 10% AGI limitation for casualty losses resulting from the Midwest disaster.
• Special Look-Back Rule for EIC and Refundable Child Credit: Since many families had their records lost or destroyed in the Midwest disaster area, the Act allows low-income working families an election to use their 2007 income amounts for purposes of determining their eligibility for the refundable earned income credit (EIC) and child credit in 2008.
• Additional Personal Exemption for Housing Victims: The Act allows taxpayers to claim an additional personal exemption of $500 for each dislocated person (up to four, or a maximum of $2,000) from the Midwest disaster whom the taxpayer houses in his or her principal residence for a minimum of 60 days. Such exemptions may be claimed in 2008 and 2009, but cannot be claimed in both years for the same person.
• Cancellations of Indebtedness Exclusion: Taxpayers will not be taxed on amounts realized from the discharge of indebtedness that results from the Midwest disaster. For example, if a lender discharges all or part of a taxpayers’ mortgage debt due to damage to the taxpayer’s home, this will not be treated as income for the individual taxpayer.
• Extension of Replacement Period for Lost Property: The Act extends to five years (it was four) the replacement period for principal residences that were damaged or destroyed within the Midwest disaster area as long as the replacement property is located in the same county.

CATEGORY 2: RELIEF FOR ALL COUNTIES DECLARED ELIGIBLE FOR INDIVIDUAL ASSISTANCE OR INDIVIDUAL AND PUBLIC ASSISTANCE

• Expansion of Hope Scholarship and Lifetime Learning Credits: The Act doubles the maximum Hope Scholarship credit to $3,600 and doubles the Lifetime Learning credit percentage from 20% to 40% (making the maximum Lifetime learning credit $4,000). This applies to individuals attending an eligible educational institution located in the Midwest disaster area in years beginning in 2008 or 2009. In addition, the Act states that room, board, books, and fees are qualified expenses.
• Gives Treasury Department Authority to Adjust Taxpayer and Dependant Status: The Act allows the IRS to make adjustments to ensure taxpayers do not lose deductions or credits, or experience a change in filing status due to a dislocation caused by the Midwest disaster.
• Charitable Relief for Disaster Area: The Act gives the following incentives for charitable giving in the Midwest disaster area:
• Temporarily Suspends Charitable Contribution Limitations: The Act temporarily waives, for 2008, the limitation for charitable deductions for cash donations that exceed 50% of an individual’s AGI, as long as they are used for the Midwest disaster area.
• Increases Standard Mileage Rate for Charitable Use of Vehicles: When using a vehicle for charitable work on or after the date of the disaster, through 2008, an individual may use 70% of the business mileage rate effective at that time. Thus, an individual can use a charitable mileage rate of 35.4 cents (70% of 50.5 cents) for the first half of 2008 and 41 cents (70% of 58.5 cents) for the second half of 2008.
• Exclusion for Volunteer’s Mileage Reimbursement: Beginning on or after the date of the disaster, through 2008, an individual using their personal vehicle for charitable work in the disaster area may exclude from income reimbursements for mileage attributable to work in the Midwest disaster area.

Tax Relief for Victims of Federally-Declared Disasters

The Act provides the following tax relief for individual taxpayers who are victims of any federally-declared disaster that occurs after December 31, 2007 and before January 1, 2010:

• Eases Casualty Loss Rules: The Act waives the 10% AGI limitation and raises the current $100 limitation to $500. In addition, the Act allows non-itemizers to increase their standard deduction by the net disaster loss.
• Mortgage Revenue Bonds: The Act allows states to issue tax-exempt bonds to finance low-interest loans to taxpayers whose principal residences were damaged in the disaster.

Energy Incentives

• Residential Energy-Efficient Property Credit: The Act extends the credit for residential energy-efficient property for eight years, through 2016. It also removes the $2,000 limitation on the credit for solar electric property. The Act adds both residential small wind energy property (up to $4,000) and geothermal heat pumps (up to $2,000) to the list of energy-efficient property.
• Credit for Energy-Efficiency Improvements to Existing Homes: The Act allows the credit for making qualifying energy saving improvements to existing homes in 2009. (This credit expired for property placed in service after 2007 and will not be available in 2008.) The Act adds biomass fuel stoves as a new class eligible for a credit of $300. It also clarifies the efficiency standard for water heaters.
• Credit for Plug-In Electric Drive Motor Vehicles: The Act creates a credit for purchasing a qualified plug-in electric drive motor vehicle for tax years beginning after December 31, 2008, for vehicles purchased before January 1, 2015. The credit amount is $2,500, plus $417 for each kilowatt hour of “traction battery capacity in excess of 4 kilowatt hours.” The amount of the credit is limited based on the vehicle’s weight: $7,500 for a qualifying vehicle with a gross vehicle weight rating of not more than 10,000 pounds, up to $15,000 for a vehicle with a gross vehicle weight rating of more than 26,000 pounds. There is a phase-out of the credit based on the number of qualifying vehicles sold (250,000 vehicles is the threshold amount).
• Bicycle Commuters:Starting in 2009, the Act adds a bicycle commuting reimbursement as a qualified transportation fringe benefit. The benefit is $20 for each month during the year that the employee uses a bicycle for a substantial portion of his or her commute. Its purpose is to assist with the costs of improvements to the bicycle, repairs, and storage.

Final Note

The new release of BNA Income Tax ™ Planner, updated with changes reflecting the Emergency Economic Stabilization Act of 2008 signed by President Bush on October 3, 2008 and including 2008 AMT exemption amounts; modifications to the Minimum Tax and Child Tax Credits; extensions for the standard deduction and more, was posted to the Web October 14, 2008.

See the related articles as to how the Act will affect fixed assets management and businesses.