Tuesday, December 24, 2019
Year-End Legislation Contains Tax Extenders, Repealers and Modifications to Retirement Provisions
Last week, the Congress passed Omnibus spending bills containing multiple parts that impact retirement provisions and disaster relief tax rules. The legislation also contains certain tax extender provisions and repeals of some of the taxes contained in Obamacare. The President signed “The Further Consolidated Appropriations Act” (H.R. 1865, PL 116-94) and “The Consolidated Appropriations Act, 2020” (H.R. 1158, PL 116-93) into law on December 20. Contained in the Omnibus legislation is the “Taxpayer Certainty and Disaster Tax Relief Act of 2019” (“Disaster Act”) which provides relief for taxpayers affected by disasters in 2018 through Jan. 19, 2020. Also included in the Omnibus legislation is the “Setting Every Community Up for Retirement Enhancement Act” (SECURE Act).
New tax and retirement-related provisions – it’s the topic of today’s post.
Obamacare. The Omnibus legislation repeals the following taxes contained in Obamacare:
- Effective January 1, 2014, §9010 of Obamacare imposed an annual flat fee on covered entities engaged in the business of providing health insurance with respect to certain health risks. That tax is repealed effective for tax years beginning after 2020. Further Consolidated Appropriations Act of 2020, Div. N, Sec. 502.
- Obamacare added I.R.C. §4191(a) to impose an excise tax of 2.3 percent on the sale of a taxable medical device by the manufacturer, producer, or importer of the device for sales occurring after 2012. The new law repeals the excise tax for sales occurring after Dec. 31, 2019. Further Consolidated Appropriations Act of 2020, N, Sec. 501.
- Obamacare added I.R.C. §4980I to add a nondeductible excise tax on insurers when the aggregate value of employer-sponsored health insurance coverage for an employee, former employee, surviving spouse or other primary insured individual exceeded a threshold amount. This tax, referred to as a tax on “Cadillac” plans, is repealed for tax years beginning after 2019. Further Consolidated Appropriations Act of 2020, N Sec. 503.
Note: The PCORI taxes on insured and self-insured plans, set to expire in 2019, were extended 10 years.
The Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”) passed the house on May 23, but the Senate never took it up. Nevertheless, the SECURE Act provisions did get included in the Omnibus legislation largely unmodified. The legislation represents the first major retirement legislation since the Pension Protection Act of 2006.
Here are the key highlights of the SECURE Act:
- An increase in the required minimum distribution (RMD) age for distributions from a traditional IRA from the year in which an individual turns 70.5 to the year the individual turns 72. This provision matches the existing rules for 401(k)s and Roth IRAs. The provision is applicable to persons that did not reach age 70.5 by the end of 2019. SECURE Act §114(a), amending I.R.C. §401(a)(9(C)(i)(I).
Note: Proposed Senate legislation would set the RMD at age 75. There have also been some discussions among staffers of tax committees of exempting smaller IRA account balances from the RMD rule.
- The amount of a taxpayer’s qualified charitable distributions from an IRA direct to a qualified charity that are not includible in gross income for a tax year is reduced(but not below zero) by the excess of the total amount of IRA deductions allowed to the taxpayer for all tax years ending on or after the date the taxpayer attains age 70.5, over the total amount of reductions for all tax years preceding the current tax year. SECURE Act §107(b), amending I.R.C. §408(d)(8)(A). The provision is effective for contributions made for tax years beginning after 2019 and for distributions for tax years beginning after 2019.
- A repeal of the rule barring contributions to a traditional IRA by persons age 70.5 and up. There was no such rule that barred post-age 70.5 contributions to a Roth IRA. SECURE Act §107(a), repealing I.R.C. §219(d)(1).
- Part-time employees are allowed to contribute to a 401(k) plan. SECURE Act §112(a)(1), amending I.R.C. §412(k)(2)(D).
- The legislation provides a small employer pension plan start-up credit maximum set at the greater of $500, or the lesser of $250 for each employee of the eligible employer who is non-highly-compensated and who is eligible to participate in the plan or $5,000. Secure Act §104(a), amending I.R.C. §45E(b)(1).
- The new law expands the ability to run multiple employer plans and make the process easier overall by allowing small employers to band together to set up and offer 401(k) plans with less fiduciary liability concern and less cost than presently exists. This provision is effective for plan years beginning after 2020. SECURE Act §101, amending I.R.C. §413(e) and various portions of ERISA.
- The legislation adds a new exemption from the 10 percent penalty of I.R.C. §72(t) for early withdrawals from a retirement account. Under the provision, a parent is allowed to withdraw up to $5,000 of funds penalty-free from a 401(k), IRA or other qualified retirement plan within a year of a child’s birth or the finalization of a child’s adoption. The provision is applicable for distributions made after 2019. SECURE Act §113, amending various I.R.C. sections.
- Under prior law, funds contained in IRAs (and qualified plans) that a non-spouse inherited IRA could be withdrawn over the beneficiary’s life expectancy. Now, so-called “stretch” IRAs are eliminated by virtue of requiring non-spouse IRA beneficiaries (except for a minor child of the IRA owner, chronically ill individual, or anyone who is not more than 10 years younger than the IRA owner) to withdraw funds from inherited accounts within 10 years. Estimates are that this provision will generate at least $15 billion in additional tax revenue in the first 10 years. The provision is effective January 1, 2020. SECURE Act, §401(a)(1), amending I.R.C. §401(a)(9)(E) and (H)(ii).
Example: Harold left his IRA to his 27-year-old grandson, Samuel. Under prior law, Samuel could, based on his life expectancy, take distributions over 55 years. If the amount in the IRA at the time of Harold’s death was $1 million, Samuel’s first-year distribution would be $18,182 ($1,000,000/55). Depending on Samuel’s other income, the IRA income could be taxed at a rather low tax bracket rate or a high tax bracket rate. The amount remaining in Samuel’s inherited IRA would continue to grow over Samuel’s lifetime. Under the CAA, however, Samuel must take all distributions from the inherited IRA within 10 years of Harold’s death. As a result, Samuel will likely be placed into a much higher tax bracket. Harold could avoid this result, for example, by leaving the IRA to the Rural Law Program at Washburn University School of Law.
The provision does make sense from a policy standpoint given that the U.S. Supreme Court has held that inherited IRAs are not retirement accounts. Clark v. Rameker, 134 S. Ct. 2242 (U.S. 2014). However, the potential for a higher tax burden placed on the beneficiary will require additional estate planning and strategic Roth conversions during the account owner’s lifetime. Drafters of trust instruments should review existing trusts for clients that contain “pass-through” trusts to ensure conformity with the new rule. For trusts that don’t conform to the new rules, access to funds by heirs of IRA beneficiaries could be restricted and tax obligations could be large.
The provision applies to all qualified plans such as 401(k), 403(b) and 457(b) plans. It also applies to ESOPs, cash balance plans, 401(a) plans (defined contribution) as well as lump-sum distributions from defined benefit plans, and IRAs. However, it does not apply to a spousal rollover. When the owner dies, their spouse may roll over their spouse’s IRA into their own IRA.
The Congress allowed numerous tax provisions to expire at the end of 2017 and 2018. The CAA addresses some of the expired provisions, restoring them retroactively and extending them through 2020. Here’s a list of the more significant ones:
- The provision excluding from income qualified principal residence debt that has been forgiven (up to $2 million; $1 million for married taxpayers filing separately) is restored for 2018 and 2019 and extended through 2020. R.C. §108(a)(1)(E as amended by §101(a) of the Disaster Act. The provision also applies to qualified principal residence debt discharged via a binding written agreement entered into before 2021. Disaster Act §101(b) amending I.R.C. §108(h)(2).
- The deduction for mortgage insurance premiums is retroactively reinstated and extended through 2020. This provision is extended through 2020 for amounts paid or incurred after Dec. 31, 2017. Disaster Act §102 amending I.R.C. §163(h)(3)(E)(iv)(l).
- The medical expense deduction floor is set at 7.5 percent for 2019 and 2020. Disaster Act §103, amending I.R.C. §213(f).
- The tax code provision providing for a 3-year depreciation recovery period for race horses two years old or younger is extended for such horses placed in service before 2021. Disaster Act §114, amending I.R.C. §168(e)(3)(A)(i).
- The legislation restores the qualified tuition (and related expenses) deduction for 2018 and 2019 and extends it through 2020. Disaster Act §104, amending I.R.C. §222(e).
- The work opportunity tax credit that employers can claim for hiring individuals from specific groups is extended through 2020. R.C. §51(c)(4), as amended by §143 of the Disaster Act.
- The employer tax credit for paid family and medical leave is extended through 2020. Disaster Act §142, amending I.R.C. §45S(i).
- The biodiesel fuel tax credit is extended through 2020. Disaster Act §121(a), amending I.R.C. §40A(g).
- The tax credit for nonbusiness energy property (e.g., windows, doors, skylights, roofs, etc.) for personal residences is extended for tax years beginning after 2017 and before 2021. Disaster Act §123, amending I.R.C. §25C(g)(2).
- The tax credit for electricity produced from certain “renewable” resources is extended for qualified facilities constructed before January 1, 2021. Disaster Act §127(a), amending various subsections of I.R.C. §45(d). For wind facilities the construction of which begins in calendar year 2020, the applicable credit is reduced by 40 percent. Disaster Act §127(c)(2)(A), amending I.R.C. §45(b)(5).
- The tax credit for manufacturers of energy-efficient residential homes is extended for homes acquired before January 1, 2021. Disaster Act §129, amending I.R.C. §45L(g).
The TCJA changed the rules for deducting losses associated with casualties and disasters. The Disaster Act modifies those TCJA rules and provides that taxpayers impacted by a qualified disaster beginning January 1, 2018, and ending 60 days after the date of enactment, can make tax-favored withdrawals from retirement plans. In addition, the modification provides for an automatic 60-day filing extension of all tax deadlines for those taxpayers affected by federally declared disasters that are declared after December 20, 2019. Disaster Act §205, amending I.R.C. §7508A,
The Disaster Act also modifies the contribution limits with respect to donations by businesses and individuals giving to provide relief to those affected by disasters.
The modification to the “kiddie-tax” contained in the Tax Cuts and Jobs Act (TCJA) is repealed effective January 1, 2020, but an election can be made to have the new rules apply to the 2018 and 2019 tax years. This means that children’s unearned income will be taxed at their parents’ highest marginal tax rate rather than the rates applicable to trusts and estates, and the taxable income of a child attributable to earned income will be taxed under the rates for single individuals. SECURE Act §501(a), amending I.R.C. §1(j)(4).
What Wasn’t Addressed
There were several provisions in the TCJA that needed technical corrections. Not the least of those was the need to clarify that qualified improvement property is 15-year property. However, the nothing in the Omnibus legislation addresses this issue. The Omnibus legislation also does not increase or repeal the $10,000 limit on deductions for state and local taxes for individuals.
The changes included in the various parts of the Omnibus legislation are significant, particularly with respect to the retirement provisions. Most certainly, Roth IRAs will be an even more popular tax and retirement planning tool.
A very merry Christmas to all!