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Key Credits & Deductions to Watch For
By Nina Baxley Rogers, M.A.
In February 2009, massive changes were made to the tax law with the passage of the 2009 American Recovery and Reinvestment Act (ARRA). Although headlines focused on benefits to large financial institutions, many of the credits and deductions instituted apply directly to average taxpayers and small businesses.
Now that tax season is approaching, it's a good idea to review the changes set forth by ARRA., You'll want to discuss with your tax professional the opportunities and tax benefits that are available.
Incentives for Individuals
Making Work Pay Credit
The Making Work Pay Credit, a refundable income tax credit for 2009 and 2010, is the lesser of (1) 6.2% of the individual's earned income, or (2) $400 ($800 for married filing jointly, or MFJ). This credit is available, in full, to workers with a modified AGI of up to $75,000 ($150,000 for MFJ). Above that amount, the credit is phased out at a 2% rate. The credit applies to self-employment earnings to the extent that they're considered in computing taxable income.
Be aware that the Making Work Pay Credit does not apply to any individual whose tax return does not include a Social Security Number.
You may already be benefitting from the Making Work Pay Credit, which is handled differently from prior stimulus programs in that it isn't automatically distributed via a one-time check, but as reduced wage withholdings. For most W-2 employees, employers are already having the withholdings adjusted automatically. (The employer's share of FICA (or its 6.2% equivalent) remains unchanged). Alternately, taxpayers can take the credit as a lump sum when filing their annual tax return.
Schedule M, Making Work Pay, and Government Retiree Credits, should be included with the individual tax return, regardless of how the taxpayer takes the credit.
Economic Recovery Payment
Certain fixed-income individuals (such as disabled veterans, railroad retirees, Social Security recipients, and certain government workers) are receiving a one-time recovery payment of $250 in 2009. If the individual receives both this payment and the Making Work Pay Credit, the Making Work Pay Credit will be reduced by the $250 payment.
First-Time Homebuyer Credit (Entended - See UPDATE Below)
The First-Time Homebuyer Credit, a 2008 credit that has been widely publicized by real estate firms, was extended and changed for 2009. For home purchases made after December 31, 2008, the credit has been raised to $8,000 (from $7,500) and extended to November 30, 2009. Any required repayments to the IRS are eliminated after 36 months in the home.
As with the previous homebuyer credit, the taxpayer (1) has to have purchased the primary residence during the current calendar year, and (2) cannot have owned a residence in the U.S. during the previous three years. A taxpayer who bought a home on or after April 9, 2008, and before January 1, 2009, does not qualify for the 2009 homebuyer credit; the purchase will continue to be governed by the original 2008 credit.
Phase-outs apply for both 2008 and 2009 and begin for individuals with AGI greater than $75,000 ($150,000 for MFJ) for the year of purchase.
To claim the credit, use Form 5405 to claim the First-Time Homebuyer Credit.
UPDATE - A new law that went into effect Nov. 6 extends the first-time homebuyer credit five months and expands the eligibility requirements for purchasers.
The Worker, Homeownership, and Business Assistance Act of 2009 extends the deadline for qualifying home purchases from Nov. 30, 2009, to April 30, 2010. Additionally, if a buyer enters into a binding contract by April 30, 2010, the buyer has until June 30, 2010, to settle on the purchase.
The maximum credit amount remains at $8,000 for a first-time homebuyer –– that is, a buyer who has not owned a primary residence during the three years up to the date of purchase.
But the new law also provides a “long-time resident” credit of up to $6,500 to others who do not qualify as “first-time homebuyers.” To qualify this way, a buyer must have owned and used the same home as a principal or primary residence for at least five consecutive years of the eight-year period ending on the date of purchase of a new home as a primary residence.
For all qualifying purchases in 2010, taxpayers have the option of claiming the credit on either their 2009 or 2010 tax returns.
Income Limits Rise
The new law raises the income limits for people who purchase homes after Nov. 6. The full credit will be available to taxpayers with modified adjusted gross incomes (MAGI) up to $125,000, or $225,000 for joint filers. Those with MAGI between $125,000 and $145,000, or $225,000 and $245,000 for joint filers, are eligible for a reduced credit. Those with higher incomes do not qualify.
For homes purchased prior to Nov. 7, 2009, existing MAGI limits remain in place. The full credit is available to taxpayers with MAGI up to $75,000, or $150,000 for joint filers. Those with MAGI between $75,000 and $95,000, or $150,000 and $170,000 for joint filers, are eligible for a reduced credit. Those with higher incomes do not qualify.
New Requirements
Several new restrictions on purchases that occur after Nov. 6 go into effect with the new law:
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Dependents are not eligible to claim the credit.
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No credit is available if the purchase price of a home is more than $800,000.
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A purchaser must be at least 18 years of age on the date of purchase.
For Members of the Military
Members of the Armed Forces and certain federal employees serving outside the U.S. have an extra year to buy a principal residence in the U.S. and still qualify for the credit. An eligible taxpayer must buy or enter into a binding contract to buy a home by April 30, 2011, and settle on the purchase by June 30, 2011.
Temporary Tax Deduction on Car Purchases
This benefit is actually an above-the-line deduction for the state sales taxes, local sales taxes, and excise taxes paid by a purchaser of a new vehicle. To qualify, a taxpayer must have purchased the vehicle for first use between February 17 and December 31, 2009. The vehicle must be either (1) a passenger vehicle, light truck, or motorcycle with a gross weight of no more than 8,500 pounds, or (2) a motor home. Deductible taxes can't exceed the portion attributable to the first $49,500 of the price paid for any single vehicle. Phase-outs start for individuals with AGI greater than $125,000 ($250,000 for MFJ).
For taxpayers taking the standard deduction, this credit should be claimed on Schedule L, Standard Deduction for Certain Filers. For itemizers, use Schedule A, Itemized Deductions.
American Opportunity Tax Credit
The American Opportunity Credit is a reworking of the Hope Credit and has been enhanced in the following ways under ARRA:
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Amount increased to a maximum of $2,500 (from $1,800) per eligible student per year
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Modified rate of 100% of the first $2,000; 25% of the next $2,000, with a maximum $2,500 per year allowed on $4,000 in qualifying payments
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40% of the credit is refundable for 2009 and 2010
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Applies for all four years of college
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Qualifying expenses include course materials
The credit can be claimed by either a non-dependent taxpayer student or a parent of a qualifying student. Along with the changes listed above, the phase-out level for claiming the credit has increased to $80,000 AGI ($160,000 for MFJ).
The American Opportunity Credit is claimed using Form 8863, Education Credits.
Qualified Tuition Programs ("529 Plans")
Changes in qualifying expenses have been made to tax-free college savings plans for 2009 and 2010. A beneficiary of a qualified tuition program can now use distributions to pay for computers and computer technology (including Internet). Distributions are tax-free. (Previously, these expenses were not tax-free, were included in the beneficiary's income, and were subject to penalty.)
Earned Income Credit (EIC)
For 2009 and 2010, EIC percentage is increased to 45% of the first $12,750 of earned income for taxpayers who have three or more qualifying children. (Prior to the new law, the credit was 40% of this amount for taxpayer with two or more qualifying children.) Several forms will be modified to account for the third child: Form 8867 (Paid Preparer's Earned Income Checklist), Form 8862 (Information To Claim EIC After Disallowance), and Schedule EIC (Earned Income Credit).
In addition, the EIC phase-out range has been adjusted upward by $1,880 to eliminate any marriage penalty for joint filers.
Changes to Criteria for a Qualifying Child for EIC
The following changes do not result from ARRA, but from the Fostering Connections to Success and Increasing Adoptions Act of 2008. They are effective for tax years beginning after December 31, 2008.
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The qualifying child must be younger than the taxpayer claiming the child.
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The qualifying child must not have filed a joint return other than for a claim of refund.
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A taxpayer other than the parents of a qualifying child is allowed to claim the child, but only if the taxpayer's AGI is higher than the highest AGI of any parent of the child.
Form 8867 will be updated to reflect these additional qualifying child criteria for EIC.
Child Tax Credit
In another child-related credit, the refundable part of the Child Tax Credit is increased for 2009 and 2010. The income threshold is now set at $3,000 (down from $8,500). The full credit amount is still $1,000.
Unemployment Compensation
Generally, a taxpayer's gross income must include all unemployment compensation benefits received. In 2009 only, up to $2,400 of unemployment compensation is excluded from gross income for federal income tax purposes.
Transit Benefits
Transit passes, van pooling, qualified parking, and other qualified transportation fringe benefits are not typically included in employee income up to a certain dollar amount. In March 2009, this dollar amount was increased to $230 per month (up from $120) for transit passes and van pooling. This increased exclusion will continue through 2010 with adjustments made for inflation.
AMT Patch
Under ARRA, the Alternative Minimum Tax (AMT) patch for 2009 features the following exemption amounts:
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For joint filers and surviving spouses: $70,950 (up from $69,950)
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For singles and heads of households: $47,200 (up from $46,200)
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For married filing separate filers: $35,475 (up from $34,475)
Other Incentives for Individuals
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Property Tax Deduction – Allows homeowners up to $500 deduction ($1,000 for MFJ) of property taxes, with no itemizing required
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Teacher Expense Deduction – Allows educators a $250 deduction for out-of-pocket educational expenses, with no itemizing required
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Charitable Giving from IRAs – Allows transfer of up to $100,000 from tax-deferred retirement account to a qualified charity. Generally available to 70+ taxpayers who can make such transfers without penalty. Donation counts as a minimum distribution (cannot be deducted).
Incentives for Businesses
Bonus Depreciation
The 50% first-year bonus depreciation, a result of the 2008 Economic Stimulus Act, has been extended through December 31, 2009, and made retroactive to January 1, 2009. The additional year of bonus depreciation for certain properties is also extended through 2010. In general, property must be acquired before January 1, 2010 (or January 1, 2011 for certain property).
In addition, higher caps, effective January 1, 2009, have been placed on vehicle depreciation, with the regular dollar cap raised by $8,000 for vehicles placed in service in 2009. Limits are $10,960 for autos and $11,160 for light trucks and vans.
Refundable Credits
Instead of taking bonus depreciation, businesses can now monetize accumulated AMT and R&D credits. Originally, this election applied to 2008 only; however, this option has been extended to property that qualifies for bonus depreciation and was placed in service through 2009.
Section 179 Expensing
The 2008 Economic Stimulus Act increased the Section 179 expensing amount to $250,000, with an $800,000 threshold for reducing the deduction. Under the new law, these amounts will remain the same. (Without the extension, the expensing amount would have been limited to $125,000, with a $500,000 maximum deduction threshold.)
Longer NOL Carryback Periods
A qualified small business with average gross receipts of $15 million or less can now deduct a 2008 loss through a net operating loss (NOL) carryback period of up to five years. For NOLs incurred in 2009, the normal carryback period of two years applies.
Estimated Tax Burden Reduction
Individuals whose incomes are primarily from a small business are generally required to make quarterly estimated tax payments based on 100% of their tax returns. For 2009, these individuals can compute their estimate amounts based on 90% of the tax liability for the previous year. AGI must be less than $500,000, and the taxpayer must certify that more than 50% of gross income on the prior-year return was from a small business.
Work Opportunity Credit
The Work Opportunity Tax Credit can be elected by employers who hire individuals from one or more of certain targeted groups. This credit now covers two more groups: unemployed veterans, and disconnected youth. The new categories apply to taxpayers who are hired and begin working for the employer in 2009 and 2010.
Cancellation of Indebtedness
Beginning in 2014, certain businesses can elect to recognize cancellation of indebtedness income over five years for certain types of business debt that was repurchased by the business in 2009 or 2010. Under ARRA, an "applicable debt instrument" refers to any debt instrument issued by a C corporation or other person in connection with the conduct of a trade or business by such person. The term "debt instrument" includes a bond, debenture, note, certificate, or any other instrument constituting indebtedness.
Qualified Small Business Stock (QSBS)
An investor may now exclude 75% of the gain from the sale of certain QSBS that was (1) acquired after the date of enactment and before January 1, 2011, and (2) held for more than five years. To qualify, a small business must be an active trade or business with $50 million or less in assets.
Temporary COBRA Subsidy Continuation
Workers who are involuntarily terminated between September 1, 2008, and January 1, 2010, can elect to pay 35% of COBRA coverage and have it treated as paying the full amount. The former employer must pay the other 65% but can be reimbursed by crediting those amounts against income tax withholding and payroll taxes that it would otherwise have to pay.
If an individual receiving COBRA assistance has a modified AGI of more than $125,000 ($250,000 if MFJ), he or she should be aware that all or part of that assistance may need to be recaptured on the 1040.
Other Incentives for Businesses
Built-in Gain Period for S Corps:
Notice 2008-03 Repealed:
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Notice 2008-03 provided NOL limitation relief for corporations acquiring a financially strapped bank
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Repeal is effective for ownership changes occurring after January 26, 2009
New Markets Tax Credit Increase:
UPDATE: Increased S-Corporation and Partnership Penalties:
HR 3548 increases the penalties for late-filing tax returns for S-corporations and partnerships, including LLCs treated as partnerships. The late-filing penalty has more than doubled, from $89 to $195 per month per shareholder or partner for each month that a return is filed after the deadline (including extensions). If you have an S-corp, partnership, or LLC, be sure to file those extensions.
Business Net Operating Losses Carryback:
Businesses of all sizes can now carryback operating losses for up to five years. Previously this 5-year carryback was limited to small businesses with revenues of $15 million or less.
FUTA Surtax Extended:
The temporary surtax of 0.20 percent on the federal unemployment tax has been extended through June 2011. The FUTA rate continues to be 6.2 percent. (This surtax was scheduled to expire at the end of 2009.)
Energy Incentives
Residential Energy Property Credit
This credit is allowed for eligible property placed in service in 2009 or 2010, with the following modifications to the pre-2008 credit:
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Increase of residential energy property tax credit to 30% (from 10%)
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Increase of maximum cap to $1,500 aggregate amount for 2009 and 2010 installations
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Elimination of the $500 lifetime cap
Residential Energy-Efficient Property Credit
Modifications include removal of individual dollar caps under credit regulations for solar hot water property, geothermal heat pumps, and wind energy property. In addition, a $500 credit cap is placed on all qualified fuel cell property expenditures.
Renewable Electricity Production Credit
This credit apples for electricity produced from wind and other renewable sources. ARRA extends the placed-in-service dates for qualified facilities under Code Sec. 45 through 2012 for wind facilities, and through 2013 for most other facilities.
Investment Credit Election
Instead of producers taking the Code Sec. 45 production credit, taxpayers can treat certain alternative energy facilities as energy property eligible for a 30% investment credit under Code Sec. 48, which can be coordinated with renewable energy grants.
Alternative Fuel Pump Tax Credit
For commercial and retail stations, credit for alternative fuel vehicle refueling property is increased to 50% ($50,000 cap) of the cost of property that was placed in service by the taxpayer at each location in 2009 and 2010. For individuals, the credit is increased to 50% ($2,000 cap).
Energy Investment Credit
ARRA removes the credit cap for small wind energy property under Code Sec. 48 energy investment property. A taxpayer may be able to take a 30% credit for certain small wind energy property expenses made during the tax year.
Plug-in Electric Vehicles
An existing credit for plug-in vehicles has been modified, with separate treatment for low-speed vehicles. The credit's base amount is $2,500; the full amount will be reduced once the manufacturer records its 200,000th sale of these vehicles, which are not yet on the market. | 
