Federal Stimulus Plan Provides Major Tax Reductions for Individuals

On Friday evening, February 13, 2009, both houses of Congress reached agreement on a historic federal stimulus plan projected to cost almost $800 billion. The new plan, named the American Recovery and Reinvestment Act of 2009 (ARRA, or The Recovery Act), was signed by President Obama in a ceremony in Denver on February 17. According to the Congressional Joint Committee on Taxation (JCT) estimates, about 30% of ARRA's benefits are in the form of tax breaks for individuals ($232 billion), while the bill contains approximately $80 billion in business and energy tax reductions. This article will focus on the individual tax changes, with a companion article to follow in the next few days on the other tax changes in ARRA.

Making Work Pay CreditAMT Fix
Child Credit BoostAmerican Opportunity Tax Credit
First-time Homebuyer CreditCOBRA Continuation Assistance
Other Provisions

Making Work Pay Credit

By far the largest single-item price tag in the tax section of the bill ($116 billion according to JCT estimates) is attached to the Making Work Pay Credit, which is designed to give most U.S. taxpayers some temporary relief from the Social Security payroll taxes that are withheld from our paychecks each week (generally 6.2% of our gross wages). Congress hopes that we will spend the extra dollars that we will take home because of the credit, and therefore boost the economy.

Here's how it works. For tax years beginning in 2009 and 2010, Congress has created a refundable credit (meaning it is payable even if it exceeds the taxpayer's total tax liability) equal to the lesser of (1) 6.2% of earned income, or (2) $800 for married couples filing a joint return, and $400 for all other taxpayers. The credit phases out at a rate of 2% of the excess of the taxpayer's Adjusted Gross Income (AGI) over $150,000 for married couples, and $75,000 for all other individuals; so married couples will have no benefit from the credit if their AGI is greater than $190,000, and other taxpayers will have no benefit if their AGI is more than $95,000.

In this context, "earned income" means income from wages, tips, and other employee compensation, as well as net income from self-employment. The AGI used to determine the phase-out of the credit is the taxpayer's AGI for the current taxable year, increased by any foreign earned income excluded from U.S. income. The credit is not available to non-resident aliens working in the U.S., and it is also not allowed to taxpayers who are claimed as a dependent by someone else.

Congress has directed the IRS to issue revised withholding tables reflecting the effects of the credit, so we should start seeing the increase in our take-home pay within the next few months. Social Security taxes (identified as "FICA" taxes on most pay stubs) will still be withheld and paid into the trust fund, and the credit amount will show up as a reduction in the federal income taxes withheld.

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Temporary AMT Fix

For several years now, Congress has looked the Alternaltive Minimum Tax in the eye, and for several years Congress has blinked. This year was no exception. The revenue impact of a permanent repeal of the AMT is thought to be so huge that it seems much more prudent politically to tinker with it one year at a time. Once again, we have one-year increases in the exemption amounts allowed to taxpayers against the AMT, and most of the refundable credits are allowed as an offset for one year. Even this very limited fix has a cost associated with it of nearly $70 billion, so it is easy to see why coping with a permanent repeal is so hard for Congress to stomach.

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Child Credit Boost

Taxpayers with children age 16 or younger are entitled to a tax credit of $1,000 per child. If the credit exceeds the parent's tax liability, the parent is entitled to a refundable credit equal to 15% of the amount the parent's earned income exceeds some designated threshhold amount. For 2008, that threshhold amount was $8,500, and it was scheduled to increase to $12,550 in 2009 and be indexed for inflation thereafter. ARRA sets the threshhold for 2009 and 2010 at $3,000. This means that some lower income families will receive a larger credit than they would have otherwise. The JCT estimates the revenue impact of this provision to be $14.8 billion.

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The American Opportunity Tax Credit

Under pre-ARRA rules, taxpayers could claim up to $1,800 per year per student as a Hope Credit. The non-refundable credit was available for the first two years of post-secondary education, and the rate was 100% of the first $1,200 in qualified tuition and related expenses, and 50% of the next $1,200 tuition and related expenses. None of the credit was refundable, so it was available only to the extent of the taxpayer's tax liability. The Hope Credit phased out for married taxpayers between AGI levels of $100,000 and $120,000, and for all other taxpayers between AGI levels of $50,000 and $60,000.

The Recovery Act renames the Hope Credit as the American Opportunity Tax Credit (AOT), and it also provides some significant additional benefits, all for the 2009 and 2010 tax years only. For those years, there will be an AOT credit available of $2,500 per year per student, and it will be available for the first four years of undergraduate post-secondary education. The credit rate will be 100% of the first $2,000 of qualified tuition and related expenses, and 25% of the next $2,000 of qualified tuition and related expenses. The phaseout ranges are increased to $160,000 - 180,000 for married couples and $80,000 - 90,000 for others. Furthermore, 40% of the AOT is refundable, so that portion will be payable even if it exceeds the taxpayer's tax liability. Under the old rules, the cost of textbooks and other classroom materials could not be counted as a related expense for purposes of the credit. The AOT definition of related expenses includes textbooks and other classroom materials. The Joint Committee estimates the cost of the American Opportunity Credit to be $13.9 billion.

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First-Time Homebuyer Credit

The 2008 Housing Act introduced this provision, which was really an interest-free loan rather than a credit. As originally enacted, taxpayers who qualified as "first-time homebuyers" and bought a principal residence between January 1, 2008 and June 30, 2009 received the lesser of (a) 10% of the cost of their new home, or (b) $7,500 ($3,750 for married persons filing separate returns). To be eligible for the credit, the homebuyers could not have owned their principal residence at any time during the three-year period prior to the credit-eligible purchase. The credit phased out between AGI levels of $150,000 - 170,000 for married couples filing jointly, and $75,000 - 95,000 for other taxpayers. The "credit" had to be paid back ratably over a 15-year period without interest in the form of additions to the taxpayer's income tax liability each year.

The Recovery Act makes three alterations to the credit. First, homes purchased any time before December 1, 2009 will be eligible for the credit. Secondly, the credit amount is increased to the lesser of 10% of the cost of the home or $8,000 ($4,000 for married filing separately). Furthermore, for homes bought between January 1, 2009 and November 30, 2009, the credit will not have to be repaid, unless the taxpayer moves out of the home within 36 months after the credit-eligible purchase. The JCT staff estimates the cost of this provision to be $6.6 billion.

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COBRA Continuation Assistance

Not strictly a tax provision, but classified as such in the JCT estimates, this section of the Recovery Act provides a supplement equal to 65% of the premiums for COBRA health coverage for certain laid-off workers. In order to qualify for the assistance, the worker must be involuntarily terminated from her employment between September 1, 2008 and December 31, 2009. If a worker was involuntarily terminated before September 1, 2008 and elected out of COBRA because it was too expensive, he will have a 60-day period in which to apply for the subsidy. Individual taxpayers cannot receive the assistance payment if their income exceeds $125,000 for the year, and married couples lose the assistance at income levels of $250,000. The COBRA assistance payments are excluded from taxable income.

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Other Individual Tax Changes

There are several other important changes affecting individuals, including

  • Increases in the Earned Income Tax Credit rate for some families, as well as changes to the threshholds that will make the credit available to more taxpayers;
  • A one-year exclusion of up to $2,400 in unemployment benefits from taxable income; and
  • A deduction for sales tax and excise tax paid to purchase a new vehicle, available even if the taxpayer doesn't itemize, but not available if the taxpayer takes an itemized deduction for state income taxes paid.

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Massive in scope, The Recovery Act's individual tax provisions will put an enormous amount of additional money in the collective pockets of U.S. taxpayers, and the bulk of it will go to low and middle income individuals who are perhaps most likely to spend it quickly. It is impossible to say at this point whether the bill will accomplish its goals, so all we can do is hope - and go to the mall to spend our refund.

This page last updated 2/20/09

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