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New Tax Law Changes Affecting 2016 Returns

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The Protecting Americans from Tax Hikes (PATH) Act of 2015 (P.L. 114-113), which was enacted in late 2015, includes a number of provisions that will impact your clients’ tax returns for 2016 and beyond. Here is a rundown of key tax law changes for individual taxpayers.

Extenders Made Permanent

At long last, the new law permanently deals with some of those pesky on-again, off-again provisions collectively known as “extenders.”

State and Local Sales Tax Deduction. The PATH Act permanently extends the itemized deduction for state and local sales taxes, which may be claimed in lieu of a deduction for state and local income taxes. The optional deduction had expired for tax years beginning after 2014, but was restored retroactively for 2015 and made permanent.

Educators’ Expense Deduction. The PATH Act also permanently extends and expands a provision that allows “eligible educators” to claim deductions for up to $250 of out-of-pocket expenses for classroom-related expenses.

American Opportunity Tax Credit. Individual taxpayers can claim the American Opportunity Tax Credit (AOTC) for qualified tuition and related expenses for the first four years of a student’s post-secondary education. The maximum credit is $2,500 per year (100 percent of the first $2,000 of qualified expenses plus 25 percent of the next $2,000 of qualified expenses), subject to a phase-out for higher income taxpayers. For lower-income taxpayers, up to 40 percent of the otherwise allowable credit is refundable. The AOTC was enacted in 2009 as a “temporary” substitute for the Hope Scholarship credit. By contrast with the AOTC, the Hope credit was limited to the first two years of secondary education, subject to lower credit limits, and nonrefundable. The AOTC was scheduled to expire after 2017. The PATH Act makes the AOTC permanent.

Refundable Child Tax Credit. As a general rule, a taxpayer can claim a $1,000 child tax credit for each qualifying child. The credit is generally nonrefundable and is phased out for higher-income taxpayers. On the other hand, lower-income taxpayers whose child tax credits exceed their tax liability can claim a refundable credit (called the additional child tax credit) equal to 15 percent of earned income in excess of a threshold amount. When the additional child tax credit was introduced in 2001, the threshold amount was set at $10,000 (indexed). However, starting in 2009, the threshold amount was “temporarily” lowered to $3,000 (unindexed). The PATH Act makes the unindexed $3,000 threshold amount permanent.

Earned Income Credit. Lower-income taxpayers may qualify for tax relief through the earned income credit. The credit, which may be refundable, varies depending on the number (if any) of qualifying children in a taxpayer’s household and the taxpayer’s adjusted gross income (AGI). Starting in 2009, temporary legislation increased the credit percentage for taxpayers with three or more children and increased the income phase-out range for married taxpayers filing jointly. These provisions were scheduled to expire for tax years beginning after 2017. The PATH Act makes them permanent.

A word of caution: in connection with the permanent extension of the above credit provisions, the PATH Act adds new procedural rules to crack down on improper or inflated credit claims. See February 2017 for a discussion of the new rules.

Transportation Benefit Parity. As has been the case for the last several years, the new law retroactively increased the mass transit benefit exclusion for 2015 to an amount equal to the exclusion for qualified parking benefits. Thus, for 2015, the exclusion for transit passes and transportation in a commuter highway vehicle (transit benefits) retroactively jumped from $130 to $250 per month. However, the good news is that employers and employees will no longer have to deal with after-the-fact changes in the transit benefit exclusion. This time around, the new law provides for permanent parity between the two exclusions. For 2016, the monthly cap on both mass transit benefits and parking benefits is $255 per month.

Charitable Conservation Contributions. Contributions of capital gain property are generally limited to 30 percent of a taxpayer’s contribution base (AGI without taking into account any net operating loss carryover). A temporary provision increased the deduction limit for qualified conservation contributions of real property to 50 percent of the taxpayer’s contribution base over the amount of other allowable contributions. The enhanced deduction expired for tax years beginning after 2014. The new law retroactively restored the enhanced deduction for 2015 and made it permanent.

Charitable IRA Distributions. The new law also permanently extends a rule permitting taxpayers age 70 1/2 or older to exclude from gross income qualified charitable distributions from an individual retirement account (IRA). Tax-free distributions are limited to $100,000 each year. The exclusion had expired for 2015, but was retroactively restored and made permanent.

Not-So-Permanent Extenders

While the new law eliminated some “extenders,” others remain on the books.

Mortgage Forgiveness Exclusion. The rule permitting an exclusion from gross income for a discharge of qualified principal residence indebtedness is extended through 2016. The law change also allows the exclusion for qualified indebtedness that is discharged in 2017, if the discharge is pursuant to a written agreement entered into in 2016.

Mortgage Insurance Premium Deduction. A temporary provision, which had expired for tax years beginning after 2014, permits homeowners to treat premiums paid for mortgage insurance on a primary or secondary residence as deductible home mortgage interest. The deduction is phased out for taxpayers with AGI between $100,000 and $109,000. The deduction was retroactively restored for 2015 and extended through 2016.

Tuition and Fees Deduction. The PATH Act extends the above-the-line deduction for qualified tuition and related expenses through 2016. The maximum deduction is $4,000 for a taxpayer with AGI up to $130,000 on a joint return or $65,000 on another return. For joint filers with AGI between $130,000 and $160,000 or other filers with AGI between $65,000 and $80,000, the maximum deduction is $2,000. Taxpayers with AGI above those limits cannot claim the deduction.

Nonbusiness Energy Property Credit. The nonbusiness energy property credit is a nonrefundable credit for homeowners who install certain energy efficient property (e.g., windows and doors, insulation, heat pump systems, and water heaters) in their homes. The total credit that can be claimed for all tax years is limited to $500, no more than $200 of which can be for windows. The credit expired for property placed in service after 2014, but was retroactively reinstated for 2015 and extended for 2016.

Residential Energy Efficient Property Credit. For 2016, the residential energy efficient property (REEP) credit can be claimed for 30 percent of the cost of each of the following: solar electric property, qualified solar water heating property, qualified fuel cell property (up to a maximum credit of $500 for each 0.5 kilowatt (kw) of capacity), qualified small wind energy property, and qualified geothermal heat pump property. The REEP credit was scheduled to expire for property placed in service after December 31, 2016. The REEP credit is extended through 2021 for qualified solar electric property expenditures and qualified solar water heating property expenditures. However, the credit percentage will drop from 30 percent to 26 percent for property placed in service in 2020 and to 22 percent for property placed in service in 2021. The availability of credits for fuel cell property, wind energy property, and geothermal heat pump property will expire for property placed in service after 2016.

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