Income Tax Changes in the Emergency Economic Stabilization Act

With so much attention being given to the $700 billion bailout of banks and the financial industry in the Emergency Economic Stabilization Act of 2008, not much has been said about the individual income tax provisions included in the massive 440-page bill passed last month. If you’d like to avoid searching the full bill for the parts that might be personally relevant, here’s a quick summary of some provisions that could be interesting to you even if you’re not an enormous bank.

Alternative Minimum Tax (AMT) relief
For the last several years, Congress has been applying bailing wire and duct tape to the Alternative Minimum Tax system to keep it from pinching families to whom it was never intended to apply.  This year, breaking with its habit of tweaking the AMT right at the end of the calendar year, Congress managed to settle on the changes for 2008.  Without this change, the amount of the AMT exemption would have reverted to pre-2001 levels. The 2008 exemption, which was to have been $45,000/$37,750 for couples and singles respectively, has been increased to $69,950/$46,200.

This is only a short-term fix and the AMT will affect a wider audience in 2009 unless further changes are made. Congress has yet to provide a lasting solution to the fact that the AMT no longer does what it was originally intended to do. The alternative tax system was created to keep wealthy people from escaping taxation entirely through various loopholes. The tax was created in 1969 to ensure that people with incomes exceeding $200,000 paid at least a minimum amount of tax. Because the AMT, unlike most tax rules, does not include provision for an automatic inflation adjustment, today it affects not only high-income earners, but middle-class taxpayers as well. If the AMT had been indexed for inflation, it would now only affect those with incomes well in excess of $1 million; instead, households with incomes of less than $100,000 may be subject to AMT. The Congressional Budget Office has estimated that unless the AMT system is changed, by the end of the decade two-thirds of households with incomes between $50,000 and $100,000 will be subject to the alternative minimum tax.

The Act also provides more liberal treatment for taxpayers who were burned by the AMT as a consequence of exercising incentive stock options (ISOs). It permits eligible individuals to claim the AMT refundable credit over a shorter period of time than under previous law and eliminates the income phaseout that used to apply to this credit.  The new law also eliminated any tax underpayments outstanding on October 3, 2008 that are attributable to pre-2008 Phantom ISO income.

For 2008 only, the law allows taxpayers who are entitled to various nonrefundable personal tax credits (like the Lifetime Learning credit) to offset AMT liability as well as regular income tax liability.

Deductions and Exclusions Restored Retroactively
The following tax breaks, which expired at the end of 2007, have been restored for 2008 and 2009:

Taxpayers who itemize may take a deduction either for (1) state and local income taxes or (2) state and local sales taxes.  This primarily benefits people who live in states without an income tax.

The above-the-line deduction for qualified tuition and related expenses for higher education is restored.  Up to $4,000 is deductible for taxpayers with Adjusted Gross Incomes (AGI) of less than $130,000/$65,000 (joint vs. single) or $2,000 if AGI is less than $160,000/$80,000.

Eligible educators may deduct up to $250 above-the-line for books and other supplies.

Taxpayers age 70 1/2 and older can make a direct transfer of their IRA distribution (up to $100,000) to a qualified charity and exclude the distribution from gross income.

Deductions for Energy-Saving Home Improvements
Homeowners who add solar energy or fuel cell equipment to their homes can obtain a tax credit of 30% of the improvement costs, up to a cap of $2,000 in 2008; after that and until 2016, the 30% credit is uncapped.  The credit is also available for wind turbines and geothermal heat pumps.

Starting in 2009, the bill revives a credit that was available prior to 2008 for energy-saving improvements like insulation, windows, and new boilers. The new law expands the credit to certain types of energy-efficient biomass fuel stoves and asphalt roofs.

There’s a great deal more in such a massive bill, of course, but time would fail me to discuss (for example) the tax benefits it provides to manufacturers of children’s wooden arrows.

About the author

Thomas Fisher, CFP®

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