With year end right around the corner, Congress passed the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act). The act extended numerous tax breaks that had expired December 31, 2014, and the President signed it into law December 18.
The new law is more significant than some tax “extenders” legislation in recent years because, in addition to extending relief, the PATH Act makes quite a few tax breaks permanent and also enhances some breaks. Let’s take a look at some of the breaks that may help you save tax on your individual and business returns in 2015 and beyond.
Benefits for Businesses
Section 179 expensing election
Sec. 179 of the Internal Revenue Code (IRC) allows businesses to elect to immediately deduct — or “expense” — the cost of certain tangible personal property acquired and placed in service during the tax year, instead of recovering the costs more slowly through depreciation deductions. However, the election can only offset net income; it can’t reduce it below zero dollars to create a net operating loss.
The election is also subject to annual dollar limits. For 2014, businesses could expense up to $500,000 in qualified new or used assets, subject to a dollar-for-dollar phaseout once the cost of all qualifying property placed in service during the tax year exceeded $2 million. Without the PATH Act, the expensing limit and the phaseout amounts for 2015 would have sunk to $25,000 and $200,000, respectively.
The new law makes the 2014 limits permanent, indexing them for inflation beginning in 2016. It also makes permanent the ability to apply Sec. 179 expensing to qualified real property, reviving the 2014 limit of $250,000 on such property for 2015 but raising it to the full Sec. 179 limit beginning in 2016. Qualified real property includes qualified leasehold-improvement, restaurant and retail-improvement property.
Finally, the new law permanently includes off-the-shelf computer software on the list of qualified property. And, beginning in 2016, it adds air conditioning and heating units to the list.
If your business is eligible for full Sec. 179 expensing, you might obtain a greater benefit from it than from bonus depreciation (discussed below) because the expensing provision can allow you to deduct 100% of an asset acquisition’s cost. Moreover, you can use Sec. 179 expensing for both new and used property.
The news is mixed on bonus depreciation, which allows businesses to recover the costs of depreciable property more quickly by claiming bonus first-year depreciation for qualified assets. It’s been extended, but only through 2019 and with declining benefits in the later years. For property placed in service during 2015, 2016 and 2017, the bonus depreciation percentage is 50%. It drops to 40% for 2018 and 30% for 2019.
The provision continues to allow businesses to claim unused AMT credits in lieu of bonus depreciation. Beginning in 2016, the amount of unused AMT credits that may be claimed increases.
Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software, water utility property and qualified leasehold-improvement property. Beginning in 2016, qualified improvement property doesn’t have to be leased to be eligible for bonus depreciation.
Note that, if you qualify for Sec. 179 expensing, it could provide a greater tax benefit than bonus depreciation. (See above.) But bonus depreciation could benefit more taxpayers than Sec. 179 expensing, because it isn’t subject to any asset purchase limit or net income requirement.
Accelerated depreciation of certain qualified real property
The PATH Act permanently extends the 15-year straight-line cost recovery period for qualified leasehold improvements (alterations in a building to suit the needs of a particular tenant), qualified restaurant property and qualified retail-improvement property. The provision exempts these expenditures from the normal 39-year depreciation period.
This is especially welcome news for restaurants and retailers, which typically remodel every five to seven years. If eligible, they may first apply Sec. 179 expensing and then enjoy this accelerated depreciation on qualified expenses in excess of the applicable Sec. 179 limit.
The research credit (commonly referred to as the “research and development” or “research and experimentation” credit) provides an incentive for businesses to increase their investments in research. But businesses have long complained that the annual threat of extinction to the credit deterred them from pursuing critical research into new products and technologies.
The PATH Act permanently extends the credit. Additionally, beginning in 2016, businesses with $50 million or less in gross receipts can claim the credit against alternative minimum tax (AMT) liability, and certain start-ups (in general, those with less than $5 million in gross receipts) that haven’t yet incurred any income tax liability can use the credit against their payroll tax.
While the credit is complicated to compute, the tax savings can prove significant.
Benefits for Individuals
The American Opportunity credit (a modified version of the Hope credit) allows eligible taxpayers to take an annual credit of up to $2,500 (vs. the Hope credit maximum of $1,800) for various tuition and related expenses for each of the first four years of postsecondary education (vs. the first two years with the Hope credit). The credit phases out based on modified adjusted gross income (MAGI) beginning at $80,000 for single filers and $160,000 for joint filers, indexed for inflation.
The American Opportunity credit was scheduled to revert to the Hope credit after 2017, with the $1,800 and first-two-years limits and lower MAGI phaseout thresholds. The PATH Act makes the more beneficial American Opportunity credit permanent.
The PATH Act extends through 2016 the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for taxpayers whose adjusted gross income (AGI) doesn’t exceed $65,000 ($130,000 for joint filers) or, for those beyond those amounts, $2,000 for taxpayers whose AGI doesn’t exceed $80,000 ($160,000 for joint filers).
You can’t take the American Opportunity credit, its cousin the Lifetime Learning credit and the tuition deduction in the same year for the same student. If you’re eligible for all, the American Opportunity credit will typically be the most valuable in terms of tax savings. But in some situations, the AGI reduction from the deduction might prove more beneficial than taking the Lifetime Learning credit because the deduction ends up saving more tax than opting for the credit.
The PATH Act makes permanent the provision that allows taxpayers who are age 70½ or older to make direct contributions from their IRA to qualified charitable organizations up to $100,000 per tax year. The taxpayers can’t claim a charitable or other deduction on the contributions, but the amounts aren’t deemed taxable income and can be used to satisfy an IRA owner’s required minimum distribution.
To take advantage of the exclusion from income for IRA contributions to charities on your 2015 tax return, you’ll need to arrange a direct transfer by the IRA trustee to an eligible charity by December 31, 2015. Donor-advised funds and supporting organizations are not eligible recipients.
The law makes other tax benefits related to charitable giving permanent, too, including the enhanced deduction for contributions of real property for conservation purposes.
State and local sales tax deduction
The itemized deduction for state and local sales taxes, instead of state and local income taxes, is now permanent. The deduction is especially valuable for individuals who live in states without income taxes. It can also benefit taxpayers in other states who purchase major items, such as a car or boat.
You don’t have to keep receipts and track all the sales tax you actually pay. Your deduction can be determined by using an IRS sales tax calculator that will base the deduction on your income and the sales tax rates in your locale plus the tax you actually pay on certain major purchases.
Tax credit for nonbusiness energy property
The PATH Act extends through 2016 the credit for purchases of residential energy property. Examples include new high-efficiency heating and air conditioning systems, insulation, energy-efficient exterior windows and doors, high-efficiency water heaters and stoves that burn biomass fuel.
The provision allows a credit of 10% of expenditures for qualified energy improvements, up to a lifetime limit of $500. If you’ve been thinking about investing in some energy upgrades, you’ll want to do it before the end of next year.
The PATH Act’s temporary and permanent extensions of numerous valuable tax breaks for individuals and businesses provide significant tax planning opportunities. We’ve only touched on some of the most popular here; the new law may include other extensions and enhancements that can benefit you. We can help you identify the ones that will minimize your taxes for 2015 and chart the best course in future years.