March 1st, 2009

Summary of Significant Tax Provisions in the American Recovery and Economic Stimulus Bill of 2009

By Susan Willey

Changes affecting Business Taxpayers

- Business expensing of depreciable assets – This legislation extends for one year the tax provision that allows 50% of an asset’s cost to be immediately deducted. The new law allows a taxpayer to elect this enhanced depreciation allowance or to accelerate unused AMT credits or R & D expenses in exchange for refundable credits. The 100% expensing deduction for the first $250,000 of asset additions by businesses is extended for one year. The phase out of the benefit for immediate expensing of asset additions in excess of $800,000 is also extended through 2009. The enhanced first-year automobile depreciation deduction for new cars of $8,000 is extended through 2009 (it is added to an inflation-indexed cap that was limited to $2960 in 2008).

- 5-year NOL carryback limited to small businesses – Small businesses with gross receipts of less than $15 million may qualify for the 5-year NOL carryback provisions. NOLs eligible for carryback arise in tax years beginning or ending in 2008. The Midwestern Disaster Relief legislation grants the same benefit to all businesses, regardless of their size.

- The estimated tax safe harbor is reduced for individuals with business income who employ fewer than 500 people and have less than $500,000 of adjusted gross income in the preceding taxable year. More than 50% of gross income on an individual’s tax return must be attributable to the small business. For 2009, the estimated tax safe harbor is 90% of last year’s tax rather than 110% of last year’s tax. This change will affect owners of partnerships, LLCs, S corporations and individuals who earn salary from a C corporation.

- In 2009 and 2010, a business may claim a Work Opportunity Tax Credit for two new categories of workers: unemployed veterans and disconnected youth.

- Taxpayers may elect to defer the recognition of discharge of indebtedness income if they reacquire debt obligations in 2009 and 2010. The Act defers income associated with a 2009 reacquisition of a debt for five years and defers income recognition on the 2010 reacquisition of debt for four years. After the deferral, 20% of the cancellation of indebtedness income is included in taxable income over the next five years. This provision is designed to reduce the tax burden when an issuer of debt (or a related party) reacquires its debt.

- The capital gains exclusion for the sale of small business stock has also been enhanced. 75% of the gain on the sale of qualified small business stock is exempt from capital gains tax, increased from the current law 50% exclusion. The excludable gain is tapped at the greater of $10 million or 10 times stock basis. To qualify a shareholder must acquire these securities on original issuance from a C corporation. The stock eligible for this favorable treatment must be acquired in 2009 or 2010.

- The ten-year built-in gain recognition period for S corporations that were originally C corporations is shortened to seven years for gain recognized in 2009 or 2010. If an asset is sold in 2009 or 2010 by an S corporation that was formerly a C corporation, the built-in gain tax on the asset is not triggered if the S corporation had achieved its seventh full year as an S corporation. Parallel rules apply to assets transferred to an S corporation from a predecessor C corporation by merger or acquisition if the S corporation’s basis in its assets is determined with reference to the asset basis of the predecessor organization.

- Notice 2008-83 permitting financial institutions to ignore the loss trafficking anti-abuse rules in Sec. 382 is repealed. Transition relief is provided in the law to protect those who relied on the IRS notice. Special NOL rules apply to negotiations for TARP (Troubled Assets Relief Program) funds from the Department of Treasury.

- State housing authorities may elect to exchange 40% of their 2009 low-income housing tax credit allocation for a cash payment from the Department of Treasury for 85% of this portion of their annual low income housing tax credits.

Employee Benefit Changes

- The federal government will subsidize a portion of an individual’s COBRA premium. After February 17, 2009, a person who pays 35% of a COBRA premium is deemed to pay the entire premium. Employers will recover the balance of the premium cost through a federal tax credit applied against wage withholding and payroll taxes. This premium subsidy lasts a maximum of 9 months, and could be a shorter period of time if less than 9 months remain in the 18 month COBRA period.

Employees may elect to enroll in a different health plan within 90 days of their COBRA notice. A person who was involuntarily terminated and became eligible for COBRA beginning September 1, 2008 and ending December 31, 2009 may request the premium subsidy for premiums paid after February 17, 2009. This provision allows workers who couldn’t afford the full COBRA premium to elect back into health insurance with a premium subsidy. A recapture tax is imposed each year on employees who receive the subsidy if modified adjusted gross income exceeds $125,000 for single individuals and $250,000 for married taxpayers filing jointly.

- Executive compensation restrictions will apply to recipients of TARP funds. The new rules are designed to discourage executives from taking unnecessary risks with federal funds. The top five officers of corporations receiving these funds are generally required to have their compensation approved by an executive committee. The top 25 officers are required to repay any bonus or incentive payment if the payment that was based on inaccurate financial data.

During the time a corporation receives TARP assistance, restricted stock may not vest and a restricted stock grant cannot exceed 1/3 of the executive’s total compensation. Golden parachutes are prohibited during the TARP financial assistance period.

Financial institutions receiving less than $25 million in TARP payments will only apply these restrictions to the institution’s top officer. Financial institutions that receive $25 million to $250 million will apply these restrictions to their top five most highly compensated executives.

Financial institutions receiving $250 million to $500 million will apply the new rules to their next ten most highly compensated executives. If a financial institution receives over $500 million, these restrictions apply to their next twenty highest paid officers. Bonuses and contracts executed before February 11, 2009 are not covered by the new rules.

CEOs and CFOs must certify TARP compliance. In many cases, corporations receiving TARP funds must establish independent compensation boards.

Company policies are required to limit luxury expenditures on entertainment and events; office and facility renovation; aviation or other transportation services.

During the time a company receives TARP assistance, a special shareholder vote is required to approve compensation. The Secretary of the Treasury has the authority to review earlier compensation awards of the top 25 executives and request reimbursements to compensate the government for excessive compensation.

Changes affecting Individual Taxpayers

- Making Work Pay income tax credit – A new credit is available for individual taxpayers with modified adjusted gross income of up to $75,000 and married taxpayers with modified adjusted gross income of up to $150,000. The credit phases out as an individual’s modified AGI increases from $75,000 ($150,000 married) to $95,000 ($190,000 married). The credit is the lesser of $400 ($800 for joint filers) or 6.2% of earned income. This credit expires after 2010.

- Higher education tax benefits – For 2009 and 2010, the Act replaces the Hope Scholarship Credit for qualified expenses with the American Opportunity Tax Credit. The income phase-out limits for the Hope post-secondary education credit were increased ($80,000 for individuals and $160,000 for married filing jointly taxpayers). The maximum credit is increased to $2,500 and applies to four years, rather than two years, of college expenses. Expenses eligible for the credit now include required course materials. The credit may reduce regular and AMT liabilities. Forty percent of the credit may be refundable, as long as the taxpayer meets certain requirements.

- Computers, software, internet services and fiber optic cable are considered eligible higher education expenses for Sec. 529 college savings plans. This new provision applies to expenses incurred after Dec. 31, 2008.

- First-time Homebuyer Credit – Individuals who have not owned a home for the past three years may qualify for the first-time homebuyer’s credit. The credit is increased to $8,000 in 2009. If the home is occupied by a 2009 purchaser for three years, the credit is not recaptured. The mortgage bond financing restriction is also repealed. The credit begins to phase out at $75,000 of adjusted gross income for individuals and $150,000 for married filing jointly taxpayers.

- Unemployment compensation benefits of $2,400 or less are not subject to federal income tax in 2009.

- Sales tax deduction for the purchase of new vehicles – State sales and excise taxes attributable to the purchase of a new passenger automobile or light truck with a gross vehicle weight of less than 8500 pounds, a motor home or motorcycle are deductible. The eligibility for this deduction phases out for taxpayers with modified adjusted gross income of $125,000 for individuals and $250,000 married filing jointly taxpayers. A special provision was added to allow non-itemizers to claim the deduction. These taxes are deductible against AMT unless a taxpayer elects the general deduction for state sales tax in lieu of state income tax (this omission may be changed in a future technical correction).

Energy Efficiency Incentives

- Advanced energy projects will enjoy a 30% credit on energy expenditures that re-equip or expand a manufacturing facility employing solar, wind, battery cell and other clean technologies. The $2.3 billion program will be administered by the Department of Energy.

- The bill extends and changes energy incentives. The production tax credit is extended for three years for electricity derived from wind (through 2012). The production credit for biomass, geothermal, hydropower, landfill gas, waste-to-energy and marine facilities is extended through 2013.

- The residential energy credits for purchasing energy efficient furnaces, air conditioners, water heaters, windows, doors and insulation were expanded. The credit was increased from 10% to 30%. The credit is capped at $1500 and is available in 2009 and 2010.

- Families who purchase hybrid vehicles may qualify for an energy credit of up to $5,000. Additional tax credits are available for a variety of plug-in vehicles

Bond Financing Provisions

- Industrial Development Bonds may be used to finance facilities manufacturing intangible property if they are directly related and proximate to a manufacturing facility. This benefit applies to bonds issued in 2009 and 2010. Eligible intangibles include goodwill; going concern value; workforce in place; business books and records; patents, copyrights and other intellectual property; government license; covenant not to compete; and franchise rights. Research facilities and corporate headquarters may qualify for this financing.

- States experiencing population declines may qualify for additional bonding authority under the Recovery Zone bond program.

- The new law also authorizes $2 billion of tribal economic development bonds.

- New Markets Tax credits gain $5 billion of new authority under the stimulus legislation. The credit is designed to encourage equity investments in low income communities.

- Financial Institutions may deduct interest expense incurred to purchase tax-exempt bonds issued in 2009 and 2010. Banks may also exclude up to $30 million of small issue industrial development bonds from the interest expense disallowance rule.

- Interest income attributable to tax-exempt bonds issued in 2009 and 2010 is not added back when computing alternative minimum taxable income.

- The stimulus package contains new enhancements for School Construction bonds and Qualified Zone Academy bonds. The law creates new Build American bonds that provide a 35% federal tax credit of the amount of the interest payable on the bond. Build American bonds are tax-exempt municipal bonds that are not private activity bonds.

- Low-income housing grants and energy grants will offset a state’s bond cap.

Other Changes

- Private companies, communities, farmers and displaced employees may qualify for trade adjustment assistance if their economic distress is caused by imports from lower cost nations. Special federal funds are set aside for community colleges to retrain affected employees.

- This legislation includes payments for non-hospital based health providers to move toward an electronic health record system. Hospitals receive different incentives under the legislation to convert to electronic health records.

- A new broadband assistance program is designed to fund the cost of broadband to underserved areas, health care facilities and to schools and other public buildings.