Key Tax Changes Included with the Emergency Economic Stabilization Act of 2008

On Oct. 3, 2008, President Bush signed into law H.R. 1424 (the Act). The measure originally was designed to carry only the $700 billion financial services bailout plan (the Emergency Econom­ic Stabilization Act of 2008), but at the last minute, to increase its odds of pas­sage, it was amended to include a series of standalone tax bills that had been considered earlier by Congress (the Energy Improvement and Exten­sion Act of 2008, the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, the Heartland Disaster Tax Relief Act of 2008, and the Paul Wellstone and Pete Domenici Mental Health Parity and Addiction Equity Act of 2008), plus a separate title that includes miscellaneous tax relief provisions.

In short, the Act includes a host of tax changes affecting individuals, corporations, and businesses, such as financial bailout-related tax changes, alternative minimum tax (AMT) relief for individuals, extended tax breaks, energy incentives, disaster relief, and new tax relief measures.

Part One of our Special Study on key tax changes included with the Emergency Economic Stabilization Act of 2008 focuses on (1) AMT relief, (2) financial-bailout related changes including relief for banks, new compensation deduction limits, and debt forgiveness relief, and (3) extender provisions. Future parts will cover other significant tax aspects of this major new law.

Boosted AMT Exemption Amounts

The AMT is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative mini­mum taxable income (AMTI), which is subject to an AMT tax rate of 26% or 28%.

Under pre-Act law, an individ­ual's AMT exemption amounts for 2008 (before the phaseout) were as follows: $45,000 for married individuals filing jointly and surviving spouses; $33,750 for unmarried individuals; and $22,500 for married individuals filing separately.

Observation: These pre-Act law exemption amounts were identical to the exemption amounts that were in effect for 2000, and were far lower than the AMT exemption amounts that were in effect for 2007. Under the "Tax Increase Prevention Act of 2007,"  AMT exemption amounts (before phaseout) for 2007 for individuals were: $66,250 for married individuals filing jointly and surviving spouses; $44,350 for unmarried individuals; and $33,125 for married individuals filing separately.

New law. Under the Act, the AMT exemption amounts (before phaseout) for 2008 for individuals are:

... $69,950 for married individuals filing jointly and surviving spouses (up from $66,250 for 2007);

... $46,200 for unmarried individuals (up from $44,350 for 2007); and

... $34,975 for married individuals filing separately (up from $33,125 for 2007). (Code Sec. 55(d)(1), as amended by Act Sec. 102(a) of Division C)

Observation: The Act does not tinker with the AMT phaseout rules. Thus, the AMT exemption amounts for individuals for 2008 are as follows:

... married individuals filing jointly and surviving spouses, $69,950, less 25% of alternative minimum taxable income (AMTI) exceeding $150,000 (zero exemption when AMTI is $429,800);

... unmarried individuals, $46,200, less 25% of AMTI exceeding $112,500 (zero exemption when AMTI is $297,300); and

... married individuals filing separately, $34,975 less 25% of AMTI exceeding $75,000 (zero exemption when AMTI is $214,900), but AMTI of married indi­viduals filing separately is increased by the lesser of $34,975 or 25% of the excess of AMT] (without regard to the exemption reduction) over $214,900.

Observation: This is a temporary fix only. Absent Congressional action, the AMT exemption amounts for individuals for 2009 will revert to the levels they were at for 2000.

Personal Nonrefundable Credits May Offset AMT and Regular Tax

Under pre-Act law, personal nonrefundable credits for 2008, other than the child credit, the adoption credit, and low income saver's credit, could not exceed the excess of regular tax liability over the ten­tative minimum tax (determined without regard to the alternative minimum foreign tax credit).

New law. Under the Act, for tax years beginning in 2008, the combined total of the following credits is lim­ited to the sum of: (I) regular tax liability reduced by the foreign tax credit allowable under Code Sec. 27(a), and (2) the AMT: (Code Sec. 26(a)(2), as amended by Act 101(a) of Division C)

... Code Sec. 21 dependent care credit;

... Code Sec. 22 credit for the elderly and permanently and totally disabled;

... Code Sec. 23 adoption credit;

... Code Sec. 24 child tax credit; ... Code Sec. 25 mortgage credit;

... Code Sec. 25A Hope and Lifetime Learning credits;

... Code Sec. 25B lower income saver's credit;

... Code Sec. 25C nonbusiness energy property credit for energy-efficient improvements to a principal resi­dence;

... Code Sec. 25D residential energy efficient property credit; and

... Code Sec. 1400C first-time D.C. homebuyer credit.

Observation: In other words, under the Act, the sum of the above credits may offset both regular tax and AMT.

Illustration: In 2008, the Armstrong's regular tax is $7,400, and their tentative minimum tax is $6,500. They have $1,200 in higher education credits and no other credits. Under the Act, they may claim the full $1,200 in higher education credits. Under pre-Act law, even if they wouldn't have owed AMT, they would have been able to claim only $900 of their edu­cation credits ($7,400 minus $6,500).

Observation: As with the AMT exemption amounts, the credit fix, namely allowing credits to offset AMT and regular tax, is temporary it's just for 2008. Absent Congressional action, for 2009, most nonrefundable personal credits will be limited to the excess of regular tax liability over tentative mini­mum tax (determined without regard to the alterna­tive minimum foreign tax credit).

AMT Refundable Credit Amount Liberalized

The individual AMT attributable to deferral adjust­ments generates a minimum tax credit (MTC) that is allowable to the extent the regular tax (reduced by other nonrefundable credits) exceeds the tentative minimum tax in a future tax year. Unused MTCs are carried for­ward indefinitely.

Under the individual AMT, the exercise of an ISO is treated as the exercise of an option other than an ISO. As a result, in general, the individual takes into account as ordinary income for purposes of computing AMTI the excess of the fair market value of the stock at the date of exercise over the amount paid for the stock. When the stock is later sold, for purposes of computing capital gain or loss for purposes of AMTI, the adjusted basis of the stock includes the amount taken into account as AMTI.

An individual's MTC for any tax year beginning after Dec. 3l, 2006, and before Jan. 1, 2013, is not less than the "AMT refundable credit amount"-the amount (not in excess of the long-term unused MTC) equal to the greatest of (1) $5,000, (2) 20% of the long-term unused minimum tax credit for the tax year, or (3) the amount (if any) of the AMT refundable credit amount for the preceding tax year before any reduction by reason of the reduction for adjusted gross income (see below). The long-term unused MTC for any tax year means the portion of the MTC attributable to the adjusted net minimum tax for tax years before the 3rd tax year immediately preceding the tax year (assuming the credits are used on a first-in, first-out basis).

The additional credit allowable by reason of this provision is refundable.

For an individual whose adjusted gross income for a tax year exceeds the threshold amount at which exemptions begin to phase out under Code Sec. 15 1(d)(3)(C), see 9/18/2007 Weekly Alert, p. 450, the AMT refundable credit amount is reduced by the applicable percentage under Code Sec. 151(d)(3)(B) (i.e., the percentage reduction in the personal exemp­tion amount).

New law. For tax years beginning after 2007, the Act generally allows the long-term unused MTC to be claimed over a two-year period (rather than five years) and eliminates the AGI phase-out. (Code Sec. 53(e)(2), as amended by Act Sec. 103(a) of Division C)

It also provides that any underpayment of tax out­standing on Oct. 3, 2008 which is attributable to the application of the minimum tax adjustment for ISOs (including any interest or penalty relating thereto) is abated. No tax which is abated is taken into account in determining the MTC. (Code Sec. 53(f)(1), as amended by Act Sec. 103(b))

Observation: This provision will wipe out some large outstanding tax liabilities for some individuals who exercised ISOs when the stock was sky high and it later became worthless.

In addition, it provides that the AMT refundable credit amount and the AMT credit for each of the first two tax years beginning after Dec. 31, 2007, are increased by one-half of the amount of any interest and penalty paid before Oct. 3, 2008 on account of the application of the alternative minimum adjustment for ISOs. (Code Sec. 53(fl(2), as amended by Act Sec. 103(b))

Three-Year Extension for Home Mortgage Debt Forgiveness Relief

Taxpayers generally may exclude up to $2 million of mortgage debt forgiveness on their principal resi­dence. Specifically, Under Code Sec. 108(a)(l)(E), gross income doesn't include any discharge of qualified principal residence indebtedness. Qualified principal residence indebtedness is acquisition indebtedness under Code Sec. 163(h)(3)(B) with respect to the taxpayer's principal residence. but with a $2 million limit (Sl million for married individuals filing separately). "Principal residence" has the same meaning as under the home sale exclusion rules of Code Sec. 121. Acquisition indebted­ness of a principal residence is indebtedness incurred in the acquisition, construction, or substantial improve­ment of an Individual's principal residence that is secured by the residence. It includes refinancing of debt to the extent the amount of the refinancing doesn't exceed the amount of the refinanced indebtedness.

The basis of the taxpayer's principal residence is reduced by the excluded amount, but not below zero.

If any loan is discharged, in whole or in part, and only part of the loan is qualified principal residence indebtedness, the mortgage forgiveness exclusion applies only to so much of the amount discharged as exceeds the amount of the loan (as determined immedi­ately before the discharge) which is not qualified prin­cipal residence indebtedness.

The exclusion doesn't apply to a loan discharged on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the taxpayer's financial condition. The exclusion also doesn't apply to a taxpayer in a Title I I bankruptcy. An insolvent taxpayer (other than one in a Title I bankruptcy) can elect to have the mort­gage forgiveness exclusion not apply and can instead rely on the Code Sec. l08(a)( I )(B) exclusion for insol­vent taxpayers.

Under pre-Act law, these mortgage relief provisions are effective for indebtedness discharged on or after Jan. 1, 2007 and before Jan. 1, 2010.

New law. The Act extends the mortgage debt relief for three additional years through 2013.