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As Recovery Plan Takes Early Step in Congress, CCH Issues Special Tax Briefing

(RIVERWOODS, ILL., January 23, 2009) – President Barack Obama’s economic recovery plan took an early legislative step forward as the House Ways and Means Committee reported out a number of proposed tax changes in The American Recovery and Reinvestment Act of 2009, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).

To read a special CCH Special Tax Briefing on the bill, go to http://tax.cchgroup.com/Legislation/2009-Recovery-Act.pdf.

Once combined with other elements of the recovery plan, the bill is scheduled for a vote in the House next week. Also next week, the Senate Finance Committee will begin its consideration of the tax portion of the plan.

“Although the Finance Committee may alter or add some provisions, and there may be some accommodation to dissenting views, it’s likely that many of the provisions that we see now in the bill will eventually become law,” said Mark Luscombe, JD, LLM, CPA, CCH principal federal tax analyst.

The proposed legislation affects individuals, businesses and governments, and is aimed at increasing spending, employment, education and clean energy.

Low, Modest Incomes Benefit

Low and middle-income wage earners, individuals and families with college expenses and prospective home buyers may all benefit from the proposed changes. Those who will not benefit are those with adjusted gross incomes (AGI) above $200,000, but no one will pay more tax as a result of any of the changes.

The provision that will affect the greatest number of people is a “Making Work Pay” tax credit. The credit will be figured as 6.2 percent of taxable wages, to a maximum of $500 for single filers or $1,000 for joint filers. The credit begins to phase out at adjusted gross incomes of $75,000 for single filers and $150,000 for joint filers, diminishing by 2 percent of any amount above those levels. In effect, the credit decreases to zero when AGI hits $100,000 for single filers; $200,000 for joint filers.

“The credit is tied to employment, specifically to the 6.2-percent FICA taxes paid by employees,“ Luscombe observed. “It’s also refundable, so some people will benefit from the credit, even if they don’t owe income taxes. On the other hand, since it is based on taxable wages, the credit will not be available to many retired people and others whose income does not come from wages.”

Unlike the “stimulus rebate” credits of 2008, which were delivered in the form of a single check, the idea is for the “Making Work Pay” credit to appear as a somewhat larger paycheck, as a reduction in quarterly estimated tax payments or as a tax refund.

“The idea seems to be that if people get the credit through their paychecks, the money is more likely to get into circulation, rather than stuck into a savings account or used to pay down debt,” Luscombe said. “Changing people’s withholding can be difficult to do automatically, however. It will be interesting to see how it’s managed.”

Expanded Credit for Educational Expenses

Many people paying for college expenses will benefit from a multi-dimensional expansion of the Hope Credit for post-secondary education.

Renamed the “American Opportunity Credit” for the 2009 and 2010 tax years in which it will be available, the maximum credit amount will be $2,500 versus $1,800 under current law. It’s figured as 100 percent of eligible expenses to $2,000 plus 25 percent of expenses above $2,000, so someone with total eligible expenses of $4,000 or more would reach the maximum amount.

Unlike the existing Hope Credit, which covers expenses during only the first two years of post-secondary education, the American Opportunity Credit can be used for expenses incurred in up to four years of study. In effect, it will also largely replace the existing Lifetime Learning Credit for college expenses over the next two years.

In addition, the bill expands the kinds of expenses eligible in figuring the credit to include “course materials.”

“Up until now, you haven’t been able to include the cost of textbooks in computing the credit, yet that cost can be substantial,” Luscombe noted. “Some students attending community colleges with modest tuition costs might see a significant increase in the amount of credit they can claim.”

The credit can now be claimed by people whose incomes made them ineligible to take full advantage of the Hope Credit. It phases out with modified AGIs between $80,000 and $90,000 for single filers, or $160,000 and $180,000 for joint returns, as opposed to phaseout ranges of $50,000 to $60,000 and $100,000 to $120,000 currently.

Finally, 40 percent of the credit will be refundable, so even if a family owes no income tax due to other credits and deductions, it can receive a check for a portion of the American Opportunity Credit. However, a child cannot claim the credit unless he or she provides more than half his own support.

“These changes provide some help to families struggling with college costs in hard times and may allow some students to stay in school who would otherwise drop out,” Luscombe said. “Although a more educated workforce is probably a public benefit in the long run, it’s hard to see this providing a lot of economic stimulus right away.”

Help with Earned Income, Child Credits

The bill also helps a number of people at the lower end of the income scale. Married couples with children entitled to the Earned Income Tax Credit, or EITC, can benefit from a provision that raises the “phaseout” range of the credit, so they retain more of the credit as their incomes increase.

Low-income families also benefit from a liberalization of the refundable portion of the $1,000-per-head child credit. The new provision would take all earned income, not just income above $8,500, into account in figuring how much of the credit can be refunded, even if the taxpayer owes no other tax. This expands the number of people who can take full advantage of the refundable credit.

“The increase in the phaseout range is of greatest benefit to those in the upper half of the income range covered by the EITC, while lowering the threshold for computing the refundable portion of the child credit benefits mainly those at the lower end,” Luscombe observed. “If these changes are figured into withholding, taxpayers will have a few extra dollars in every paycheck, which they presumably will spend.”

New Rules for First-time Homebuyer Credit

The proposed legislation modifies the first-time homebuyer credit that was signed into law last year, removing a requirement that the $7,500 credit be repaid over 15 years, but the waiver applies only to houses purchased in 2009 and before the expiration of the credit on July 1. On the other hand, those who take the credit will have to repay the entire amount if they sell their homes within three years of purchase.

Under current law, those who purchased homes between April 9 and December 31, 2008, can claim the credit on their 2008 return, but must repay it over 15 years, beginning with their tax return two years after purchase. If they sell the home, they must repay the entire credit, but only up to the amount of their gain on the sale.

“Frankly, the distinction between 2008 and 2009 purchases is puzzling,” Luscombe said. “It seems strange for the people who bought a home in December 2008 to be treated so differently from those who do so in January, 2009, so I wouldn’t be surprised if somewhere along the line someone will take a second look at this.”

Businesses May Benefit

Businesses experiencing losses in 2008 and 2009 may benefit from a provision in the proposed legislation that allows them to apply the loss to previous years’ income for as many as five years before the year in which the loss takes place, potentially producing a tax refund for the prior year. Normally, losses can be “carried back” only to the two previous years.

“This can put cash back into a business quickly, and may keep a struggling business from closing its doors,” Luscombe said. “It’s not so clear that it will actually increase economic activity.”

The proposed legislation also extends two provisions that encourage businesses to invest in equipment. Bonus depreciation, which allows a business to write off 50 percent of the cost of new equipment in the first year, would be extended from 2008 to 2009. Enhanced small business expensing, which allows businesses to totally write off up to $250,000 in new equipment subject to a phaseout when capital expenditures exceed $800,000, would also be extended from 2008 to 2009.

“Many people are doubtful that these provisions actually produce any more spending on equipment than would otherwise take place,” Luscombe noted. “They argue that businesses won’t buy equipment just to get a tax break; they buy it because they believe they can increase sales and profits. It also won’t help businesses that are strapped for cash and unable to borrow. Still, not extending these breaks would probably send the wrong signal.”

The proposed law also expands the existing Work Opportunity Tax Credit, which generally gives businesses up to $2,400 to add people in targeted groups to their payrolls. It adds unemployed veterans discharged in 2008, 2009 or 2010 and “disconnected youth” – those between 16 and 25 who haven’t been regularly employed or in school for the last six months – to the list of “targeted groups.”

“This may induce employers to take on some people they see as ‘high risk,’ or who need more training than usual,” Luscombe said. “But, once again, businesses would probably have to see a genuine need for a larger workforce, not just the opportunity for a tax break, to increase their hiring.”

Credits to Create “Green Jobs”

The proposed legislation contains a number of energy-related tax provisions. Among them is removal of dollar limitations on credits for certain small wind property, solar water heating and geothermal heat pumps credits. The cap has already been removed on solar electricity property in 2008 legislation. All would be eligible for an uncapped 30-percent credit. The bill would extend the tax credits for improvements to energy-efficient existing homes through 2010 and increase the credit from 10 to 30 percent. The bill would also eliminate item-by-item dollar caps and instead provide an overall $1,500 cap. It also extends a credit for electricity produced from renewable sources, such as biomass, solar and wind – through 2012 for wind power and 2013 for other types.

“What’s being aimed at here is not so much pumping money into the economy, but creating new ‘green jobs’ in manufacturing and installing energy-efficient systems,” Luscombe noted.

Tax Incentives for State, Local, Tribal Projects

State and local governments would benefit from the proposed legislation through a variety of measures that would make their bonds easier to sell, including exempting “private activity bonds” from the alternative minimum tax. Local governments could also issue “recovery zone” bonds to finance projects in areas experiencing “significant poverty, unemployment or home foreclosures,” and Indian tribal governments would be given an expanded ability to issue bonds to finance economic development.

“These tax provisions may spur some development at a relatively low cost to the federal treasury, but a greater part of the president’s recovery plan relies on direct grants to the states for ‘shovel-ready’ projects,” Luscombe observed.

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. Wolters Kluwer is a leading global information services and publishing company. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. For more information, visit www.wolterskluwer.com.

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