On May 20, 2008, Congress passed H.R. 6081, the Heroes Earnings Assistance and Relief Tax Act (the HEART or Heroes Act), which was signed into law by President Bush on June 17, 2008. Some of the major provisions are summarized below.
Economic Stimulus payment requirements
The Economic Stimulus Act of 2008 included provisions creating a recovery rebate credit for 2008, refundable in 2008 for qualifying individuals. The amount of the credit can be up to $600 for individuals and up to $1,200 for families, plus an additional $300 per child. The IRS began issuing these “Economic Stimulus Payments” in late April, 2008.
Among the qualifications for this credit is the requirement that an individual have a valid Social Security number; in the case of a joint return, both spouses must have valid Social Security numbers. The Act provides that the requirement of valid Social Security numbers does not apply in the case of a joint return where at least one spouse is a member of the Armed Forces of the United States at any time during the taxable year.
Election to treat combat pay as earned income for purposes of the earned income credit
Combat pay that is otherwise excluded from gross income (under IRC Section 112) is treated as earned income for purposes of calculating the refundable portion of the child credit. Any taxpayer may elect to treat combat pay that is otherwise excluded from gross income as earned income for purposes of the earned income credit (prior to the Act, this election was not available after December 31, 2007).
The Act permanently extends the availability of the election to treat combat pay that is otherwise excluded from gross income as earned income for purposes of the earned income credit, effective for taxable years beginning after December 31, 2007.
New qualified plan requirement for participants who die while performing military service
The Act adds a new tax qualification requirement for retirement plans that are qualified under IRC Section 401(a) (a “tax-qualified plan”), as well as 403(b) plans and 457(b) plans. Under the new requirement, a tax-qualified plan must provide that, in the case of a participant who dies while performing qualified military service, the survivors of the participant must be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would be provided under the plan had the participant resumed employment with the employer maintaining the plan and then terminated employment on account of death.
For example, if a plan provides for accelerated vesting, ancillary life insurance benefits, or other survivor benefits that are contingent upon a participant’s termination of employment on account of death, the plan must provide such benefits to the beneficiary of a participant who dies during qualified military service. In addition, for benefit accrual purposes, the Act permits a retirement plan to treat an individual who leaves service with the plan’s sponsoring employer for qualified military service, and who cannot be reemployed on account of death or disability, as if the individual had been rehired as of the day before death or disability (a “deemed rehired employee”) and then had terminated employment on the date of death or disability. Several requirements apply (e.g., all employees performing qualified military service who die or become disabled must be credited with benefits on a reasonably equivalent basis).
In general, a plan must be amended on or before the last day of the plan year beginning on or after January 1, 2010. This provision applies in the case of deaths and disabilities occurring on or after January 1, 2007.
Differential military pay
Differential military pay treated as wages
Differential pay is compensation paid to an employee who is called to active duty with the United States uniformed services, by an employer, for the purpose of maintaining the level of compensation that the servicemember would otherwise have received from the employer during the servicemember’s period of active duty.
The Act includes as wages, for purposes of the Federal income tax withholding rules, the employer’s payment of any differential wage payment to the employee. Differential wage payment is defined as any payment which: (1) is made by an employer to an individual with respect to any period during which the individual is performing service in the uniformed services while on active duty for a period of more than 30 days; and (2) represents all or a portion of the wages that the individual would have received from the employer if the individual were performing services for the employer. In addition:
- Differential pay is considered compensation for retirement plan purposes.
- Differential pay is considered compensation for purposes of limitations on IRA contributions.
- While differential pay is considered compensation for retirement plan purposes, an individual receiving such payments will not be restricted from accessing plan funds by the rules that apply to in-service distributions, although there are negative consequences for individuals who receive distributions in this manner (individuals are unable to make elective deferrals or employee contributions for six months).
A plan or annuity contract may be retroactively amended to comply with this provision provided that the amendment is made no later than the last day of the first plan year beginning on or after January 1, 2010. For purposes of the wage withholding rules, this provision is effective with respect to differential pay paid after December 31, 2008. Otherwise, this provision is effective with respect to years beginning after December 31, 2008.
Employer credit for differential military pay
For qualified eligible small business employers, the Act establishes a tax credit in an amount equal to 20 percent of the sum of the eligible differential wage payments for each of the taxpayer’s qualified employees for the taxable year.
A qualified employee of a taxpayer is a person who has been an employee for the 91-day period immediately preceding the period for which any differential wage payment is made.
Differential wage payments means any payment which: (1) is made by an employer to an individual with respect to any period during which the individual is performing service in the uniformed services of the United States while on active duty for a period of more than 30 days; and (2) represents all or a portion of the wages that the individual would have received from the employer if the individual were performing services for the employer.
The term eligible differential wage payments means so much of the differential wage payments paid to a qualified employee as does not exceed $20,000. An eligible small business employer means, with respect to a taxable year, any taxpayer which: (1) employed on average less than 50 employees on business days during the taxable year; and (2) under a written plan of the taxpayer, provides eligible differential wage payments to every qualified employee of the taxpayer.
No deduction may be taken for that portion of compensation which is equal to the credit. In addition, the amount of any other credit otherwise allowable with respect to compensation paid to an employee must generally be reduced by the differential wage payment credit allowed with respect to such employee. Under the provision, the differential wage payment credit is part of the general business credit, and thus this credit is subject to the rules applicable to business credits. For example, an unused credit generally may be carried back to the taxable year that precedes the unused credit.
This provision is effective with respect to amounts paid after June 17, 2008 and before January 1, 2010.
Contributions of military death gratuities to Roth IRAs and Coverdell ESAs
The Act permits an individual who receives a military death gratuity or Servicemembers’ Group Life Insurance (“SGLI”) program payment to contribute the funds to a Roth IRA, or to one or more Coverdell education savings accounts.
Such contributions will be treated as rollover contributions to the Roth IRA or Coverdell ESA accounts, not subject to normal income or contribution limits. The maximum amount that can be contributed to a Roth IRA or one or more Coverdell education savings accounts in the aggregate under the provision is limited to the sum of the gratuity and SGLI payments that the individual receives.
In the event of a subsequent distribution from a Roth IRA that is not a qualified distribution or a distribution from a Coverdell education savings account that is not a qualified education distribution, the amount of the distribution attributable to the contribution of the military death gratuity or SGLI payment is treated as nontaxable investment in the contract. This provision is generally effective with respect to payments made on account of deaths from injuries occurring on or after June 17, 2008.
In addition, the provision permits the contribution to a Roth IRA or a Coverdell education savings account of a military death gratuity or SGLI payment received by an individual with respect to a death from injury occurring on or after October 7, 2001 and before June 17, 2008 if the individual makes the contribution to the account no later than June 17, 2009.
Qualified flexible spending account (FSA) reservist distributions
The Act allows a flexible spending account (FSA) to make qualified reservist distributions.
A qualified reservist distribution means a distribution to a participant in a health FSA of all or a portion of the participant’s FSA balance if (1) the participant is a reservist called to active duty for a period of at least 180 days (or is called for an indefinite period) and (2) the distribution is made during the period beginning with the call to active duty and ending on the last day of the coverage period of the FSA that includes the date of the call to active duty.
This provision is effective for distributions made after June 17, 2008.
Supplemental security income (SSI)
- Expands the definition of earned income for the supplemental security income (SSI) program to include all cash remuneration paid to members of the uniformed services and not otherwise excluded by law. Hostile fire pay and imminent danger would continue to be excluded from the SSI income calculation.
- Specifies that any money paid by a State to a blind, disabled, or aged veteran is excluded from the SSI income calculation. The provision also specifies that the value of any money paid by a State to such veteran shall not be counted as a resource by the SSI program in that month.
- Specifies that any cash or in-kind benefit paid to a participant in the AmeriCorps program is excluded from the SSI income calculation.
These provisions are effective for benefits payable for months beginning on or after September 1, 2008.
New rules for expatriates
The Act applies new tax rules to certain U.S. citizens who relinquish their U.S. citizenship and certain long-term U.S. residents who terminate their U.S. residency. In general:
- Such individuals are subject to income tax on the net unrealized gain in their property as if the property had been sold for its fair market value on the day before the expatriation or residency termination (“mark-to-market tax”).
- Gain from the deemed sale is taken into account at that time without regard to other Internal Revenue Code (IRC) provisions.
- Any loss from the deemed sale generally is taken into account to the extent otherwise provided in the IRC, except that the wash sale rules of IRC Section 1091 do not apply.
- Any net gain on the deemed sale is recognized to the extent it exceeds $600,000. The $600,000 amount is increased by a cost of living adjustment factor for calendar years after 2008.
- Any gains or losses subsequently realized are to be adjusted for gains and losses taken into account under the deemed sale rules, without regard to the $600,000 exemption.
- Deferred compensation items, interests in nongrantor trusts, and specified tax deferred accounts are excepted from the mark-to-market tax but are subject to special rules.
- A transfer tax is imposed on certain transfers to U.S. persons from certain U.S. citizens who relinquished their U.S. citizenship and certain long-term U.S. residents who terminated their U.S. residency, or from their estates.
These rules apply to any U.S. citizen who relinquishes citizenship and any long-term resident who terminates U.S. residency, if such individual:
- Has an average annual net income tax liability for the five preceding years ending before the date of the loss of U.S. citizenship or residency termination that exceeds $124,000 (as adjusted for inflation after 2004 – $139,000 in 2008);
- Has a net worth of $2 million or more on such date; or
- Fails to certify under penalties of perjury that he or she has complied with all U.S. Federal tax obligations for the preceding five years or fails to submit such evidence of compliance as the Secretary may require.
Exceptions (these exceptions do not apply to an individual who fails to certify under penalties of perjury that he or she has complied with all U.S. Federal tax obligations for the preceding five years or fails to submit such evidence of compliance as the Secretary may require):
- The first exception applies to an individual who was born with citizenship both in the United States and in another country; provided that (1) as of the expatriation date the individual continues to be a citizen of, and is taxed as a resident of, such other country, and (2) the individual has been a resident of the United States (under the substantial presence test of IRC Section 7701(b)(1)(A)(ii)) for not more than 10 taxable years during the 15-year taxable year period ending with the taxable year of expatriation.
- The second exception applies to a U.S. citizen who relinquishes U.S. citizenship before reaching age 18½, provided that the individual was a resident of the United States (under the substantial presence test of IRC Section 7701(b)(1)(A)(ii)) for no more than 10 taxable years before such relinquishment.
These rules are generally effective for U.S. citizens who relinquish citizenship or long term residents who terminate their residency on or after June 17, 2008. The rules relating to covered gifts and bequests is effective for gifts and bequests received on or after June 17, 2008, from former citizens or former long-term residents (or the estates of such persons) whose expatriation date is on or after June 17, 2008.
Other provisions worth noting
- Extends provisions related to qualified mortgage bonds, and makes changes to the rules relating to qualified veterans’ mortgage bonds that are favorable to veterans.
- Extends the time period for filing claims for credits or refunds for retired military personnel who receive disability determinations from the Department of Veterans Affairs (e.g., determinations after the tax return is filed). For determinations after the date of enactment, the period is extended until one year after the date of the disability determination (if later than the time periods allowed under present law), and applies to any taxable year which begins five years or less before the date of the determination or thereafter. In the case of a determination after December 31, 2000, and on or before June 17, 2008, the period for filing a claim for credit or refund is extended until June 17, 2009 (if later than the time periods allowed under present law).
- Makes permanent the rules relating to qualified reservist distributions (Pension Protection Act provisions expired December 31, 2007).
- Effective for tax years beginning after December 31, 2007, the Act suspends the five-year period relating to the exclusion of capital gain from the sale of a principal residence for qualifying Peace Corp. volunteers (maximum 10 year suspension period).
- Makes permanent existing provisions allowing qualified employees of the intelligence community to suspend the five-year period relating to the exclusion of capital gain from the sale of a principal residence for a period of up to 10 years (existing provisions were scheduled to expire after 2010), and repeals the requirement that members of the intelligence community must move to a duty station outside of the United States to qualify for the exclusion.
- Excludes from gross income State or local payments of bonuses to active or former military personnel or their dependents by reason of such personnel’s service in a combat zone.
- Clarifies that any qualified State or local tax benefit or reimbursement payment paid to members of qualified volunteer emergency response organizations that is excluded from gross income, is not subject to social security tax or unemployment tax.
- Increases the minimum penalty for a failure to file a tax return within 60 days of the due date to the lesser of $135 or 100 percent of the amount of tax required to be shown on the return, effective for tax returns required to be filed after December 31, 2008.