In late December, Congress reached agreement on a massive government-wide spending package – titled the Further Consolidated Appropriations Act, 2020 – that extends certain income tax provisions that had expired, as well as some that were due to expire at the end of 2019. Congress traditionally passes so-called “extenders” annually, but it neglected to do so for 2018. As a result, several popular breaks for both individuals and businesses expired at the end of 2017.
The agreement also includes the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The law is the first significant retirement-related legislation since the Pension Protection Act of 2006.
Extended tax breaks
Among others, the new legislation extends the following tax provisions through 2020, some of which were established on a temporary basis by the Tax Cuts and Jobs Act (TCJA):
Exclusion of discharge of mortgage debt
Homeowners who have undergone foreclosure, a short sale or a loan modification, or otherwise had mortgage debt forgiven, can exclude up to $2 million of the debt from their gross income ($1 million for married individuals filing separately). The debt generally must have resulted from the acquisition, construction or substantial improvement of their principal residence. The law also modifies the exclusion to make it apply to debt discharged under a binding written agreement entered into before January 1, 2021.
Before this change, the exclusion applied only to debt forgiven in calendar years through 2017 and debt discharged in 2018 under a written agreement entered into in 2017.
Deduction for mortgage insurance premiums
Homeowners now can continue to treat their qualified mortgage insurance premiums as deductible mortgage interest – assuming they itemize their deductions. The deduction begins to phase out when adjusted gross income (AGI) exceeds $100,000 ($50,000 if married filing separately). This deduction had expired at the end of 2017.
Deduction for unreimbursed medical expenses
The TCJA reduced the threshold for deducting unreimbursed medical expenses from 10% to 7.5% of AGI for 2017 and 2018. The lower threshold now has been extended through 2020. Qualified medical expenses in excess of the threshold can be claimed as an itemized deduction.
Qualified medical expenses include payments to physicians, dentists and other medical practitioners, as well as for certain equipment (including glasses, contacts and hearing aids), supplies, diagnostic devices and prescription drugs. Travel expenses related to medical care are also deductible.
Deduction for qualified tuition and related expenses
The above-the-line deduction for higher education expenses reduces a taxpayer’s AGI and is available regardless of whether the taxpayer itemizes (though it generally can’t be taken if certain tax credits for education expenses are claimed). The deduction is limited to $4,000 for individual taxpayers whose AGI doesn’t exceed $65,000 ($130,000 for joint filers) or $2,000 for individuals whose AGI doesn’t exceed $80,000 ($160,000 for joint filers). This deduction had expired at the end of 2017.
Incentives for empowerment zones
The law extends the incentives – including tax-exempt bonds, employment credits, increased expensing on qualifying equipment and capital gains deferral on the sale of qualified assets sold and replaced – for eligible businesses and employers to operate in the 41 specifically designated economically distressed areas.
New Markets Tax Credit (NMTC)
Businesses can earn NMTCs for investments in real estate projects, community facilities and operating businesses in low-income communities. The credit generally equals 39% of the original investment amount, claimed over a period of seven years beginning on the date of the investment.
The new law provides a $5 billion allocation for the credit for 2020 and extends for one year, through 2025, the carryover period for unused credits (that is, carrying over from years in which the credit amount exceeds the taxpayer’s tax liability). In certain circumstances, the NMTC can enhance the tax benefits of investing in empowerment zones.
Employer tax credit for paid family and medical leave
The TCJA created a new tax credit for certain employers that provide paid family and medical leave but made it available only for 2018 and 2019. Eligible employers can now claim the credit through 2020 if they have a written policy providing at least two weeks of such leave annually to all qualifying employees, both full- and part-time (the requisite leave for part-timers is determined on a prorated basis) and meet certain other requirements.
The amount of the credit begins at 12.5% of wages paid if the leave payment rate is at least 50% of the normal wage rate. The percentage rises incrementally by 0.25 percentage points as the rate of leave payment exceeds 50%, with a maximum credit of 25% when full wages are paid for the leave.
The maximum amount of family and medical leave that may be considered with respect to any qualifying employee is 12 weeks per tax year.
Work Opportunity Tax Credit (WOTC)
The WOTC was due to expire at the end of 2019. It is available to employers that hire individuals who are members of 10 targeted groups, including certain qualified veterans, ex-felons and certain individuals receiving state benefits. Employers that hire such employees can claim the tax credit as a general business credit against their income tax.
Changes to retirement plans
The SECURE Act is packed with more than two dozen provisions primarily intended to encourage saving for retirement. Most of the provisions take effect January 1, 2020. They include measures affecting both individuals and businesses.
- Under current law, individuals are prohibited from contributing to traditional IRAs after they reach age 70½, regardless of whether they are still working. The SECURE Act eliminates that restriction so that anyone can contribute as long as they are working, matching the existing rules for 401(k) plans and Roth IRAs.
- The SECURE Act raises the age at which taxpayers generally must begin to take their required minimum distributions (RMDs) from 70½ to 72. The new rule applies only to those individuals who haven’t reached the age of 70½ by the end of 2019.
- The law also includes a new exemption from the 10% tax penalty on early withdrawals from retirement accounts. Taxpayers can withdraw an aggregate of $5,000 from a plan without penalty within one year of the birth of a child or an adoption becoming final.
- Less favorably for individual taxpayers, the SECURE Act eliminates the “stretch” RMD provisions that have permitted beneficiaries of inherited retirement accounts to spread the distributions over their life expectancies. This allowed younger beneficiaries to take smaller distributions while growing the accounts and deferring taxes.
Now, most non-spouse beneficiaries must take their distributions over a 10-year period beginning on the deceased’s death. That could increase the tax burden by pushing the distributions into years when the beneficiary is working and in higher tax brackets. The change, therefore, could require some modifications to estate plans, particularly if the plans include trustee-managed inherited IRAs with guardrails to prevent young beneficiaries from quickly draining the accounts.
- On the business side, the SECURE Act expands access to open multiple employer plans (MEPs). MEPs give smaller, unrelated businesses the opportunity to team up to provide defined contribution plans at a lower cost, due to economies of scale, with looser fiduciary duties. It also provides tax credits to employers for starting retirement plans and automatically enrolling employees.
- In addition, the new law paves the way for employers to include annuities in their retirement plans by eliminating their potential liability when it comes to selecting the appropriate annuity plans.
- The SECURE Act requires employers to allow participation in their retirement plans by part-time employees who’ve worked at least 1,000 hours in one year (about 20 hours per week) (counting only periods of service completed on or after Jan. 1, 2021) or three consecutive years of at least 500 hours.
- New rules increase the tax credit for retirement plan start-up costs to make it more affordable for small businesses to set them up. Starting in 2020, the credit is increased by changing the calculation of the flat dollar amount limit to: the greater of $500 or the lesser of: a) $250 multiplied by the number of non-highly compensated employees of the eligible employer who are eligible to participate in the plan, or b) $5,000.
- Beginning in 2020, there’s a new tax credit of up to $500 per year to employers to defray start-up costs for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment. This credit is on top of an existing plan start-up credit described above and is available for three years. It is also available to employers who convert an existing plan to a plan with automatic enrollment.