Tax News for Homebuyers and Retirement Savers

There is important tax news for:

First-time homebuyers who are eligible to claim a tax credit of up to $8,000 and are facing an upcoming deadline.
Taxpayers interested in buying Savings Bonds with their refunds.
Employers who want to expand auto enrollment in retirement plans.
Employees who want to convert unused leave time into retirement savings.

THE IRS OFFERS GUIDANCE TO ENCOURAGE SAVINGS

As part of a concentrated effort to encourage saving for the future, the IRS recently issued guidance providing enhanced tax incentives and clarifications. The new initiatives focus on automatic enrollment plans, unused leave, tax refunds and retirement plan rollovers.

Here is a brief summary of the key points.

Unused Leave Time – Some employers allow employees to “bank” or carry over unused leave time from year-to-year. Typically, an employee who has accumulated personal days (such as vacation time and sick days) is compensated for the unused leave time when he or she changes jobs, quits or retires.

A new IRS ruling explains how a departing employee can contribute the dollar-equivalent of unused leave to a qualified retirement plan. (IRS Revenue Ruling 2009-31) In some cases, the unused leave may be forfeited and contributed to the plan. Other times, a participant can contribute the dollar-equivalent of unused paid time that can’t be carried over to the next year.

In a companion ruling, the IRS addresses various issues that arise when contributions of unused leave time are paid after termination of employment. (IRS Revenue Ruling 2009-32) In essence, they are treated as non-elective contributions.

Refunds – Effective for 2009 tax returns filed in 2010, you will be able to check a box on your tax return that allocates all or part of a refund toward the purchase of Series I U.S. Savings Bonds. These bonds offer inflation protection to investors.

Initially, the Series I Savings Bonds may only be issued in your name (or in the names of you and your spouse, if you file jointly). In 2011, the IRS intends to expand this feature to co-owners, such as a child or grandchild. More information about the new refund option is posted on the IRS Web site and can be read by clicking here.

Automatic enrollment – With an automatic enrollment 401(k) plan, employees are generally included as default participants, even if they didn’t proactively elect to take part. This feature is designed to increase participation so employers can satisfy strict nondiscrimination tests. In a new Notice, the IRS encourages employers to use auto enrollment as long as the plan gives employees proper notice and otherwise complies with relevant regulations (IRS Notice 2009-65).

The Notice provides sample language that plan sponsors can use and get automatic IRS approval. Otherwise, they must apply for approval from the tax agency.

A related Notice provides guidance on including the automatic enrollment feature in a SIMPLE-IRA plan (IRS Notice 2009-67). Short for “Savings Incentive Match Plan for Employees,” these plans are only available to employers with only 100 or fewer staff members.

Finally, the IRS issued a new ruling allowing a 401(k) plan to use default contributions that increase over time to keep pace with pay raises. (IRS Revenue Ruling 2009-30)

Rollovers – Another new IRS Notice provides long-awaited safe-harbor rules relating to rollovers from 401(k) plans, Roth IRAs and other retirement arrangements. It describes in “plain English” how employees leaving jobs can rollover their savings to other accounts, and explains rules that apply in special situations such as when distributions are paid to a surviving spouse or other beneficiary. (IRS Notice 2009-68 [PDF download - 68 KB])

Employers can give departing employees this “road map” to help avoid early withdrawals and related tax penalties.

Despite the flurry of new IRS guidance, retirement plans remain a complex area of the law. Consult with your retirement plan tax adviser for more information.

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TIME IS RUNNING OUT ON THE FIRST-TIME HOMEBUYER TAX CREDIT

The deadline is fast approaching to take advantage of the valuable federal tax credit for first-time homebuyers, which is worth up to $8,000 for 2009 purchases.

The American Recovery and Reinvestment Act of 2009 made the first-time homebuyer credit more generous than a credit available for purchases made last year. For a qualified home purchase between January 1 and November 30, 2009, the maximum credit equals the lesser of:

10 percent of the purchase price of a principal residence or
$8,000 (or $4,000 for those who are married but file separately).

To qualify for the credit, the home sale must close by Monday, November 30. Merely having a contract by that date is not enough.

To make matters worse, Thanksgiving falls on November 26 this year, which means a day off for most people involved in the home buying process, such as banks, title companies, home inspectors, attorneys and real estate agents. So there will be large numbers of homebuyers trying to find a property, secure a mortgage, and fit the closing in by November 30.

The National Association of Realtors estimates that the entire process can take up to two months. Keep in mind that around the Thanksgiving holiday weekend, many businesses will be operating with reduced staff levels and may close early.

Who Is Eligible?

Eligibility for the credit is limited to those who haven’t owned a principal residence in the U.S. during the three-year period that ends on the purchase date. In the case of a married couple, both spouses must pass this test (even if they don’t file jointly). So you don’t really have to be a first-time homebuyer.

For a newly constructed home, the purchase date is considered the move-in date. To qualify, the residence cannot be bought from a spouse, parent, grandparent, child, or certain other related parties.

The credit is reduced or eliminated if modified adjusted gross income (MAGI) is too high. The phase-out range for single filers and married individuals who file separately is between MAGI of $75,000 and $95,000. For joint filers, it is between MAGI of $150,000 and $170,000.

Under the old rules, which expired on December 31, 2008, the credit was worth up to $7,500 and all homebuyers were generally required to repay it over 15 years. The Recovery Act eliminates the 15-year repayment rule for purchases between January 1 and November 30, 2009.

However, even under the new liberalized rules that apply for 2009, buyers may have to repay the credit if they sell or stop using the home as their principal residence within three years of the purchase date. In such cases, the credit must generally be repaid by remitting it with the tax return for the year the triggering event occurs. However, the amount due cannot exceed the gain from selling the home. For gain calculation purposes, the basis of the home is reduced by the credit amount.

A divorce-related home transfer for which the credit was claimed won’t trigger the repayment rule. Instead, the spouse who winds up owning the home takes over any repayment obligation.

If a homebuyer dies, the repayment obligation is eliminated.

Could the Credit Be Extended?

Realtors and other organizations are lobbying Congress to extend the first-time homebuyer credit and even make it larger in order to continue the real estate market recovery. We’ll keep you posted of any developments

BUSINESS WISDOM FOR TODAY’S ECONOMY

The “Cash for Clunkers” program has ended but there is still a federal tax deduction for qualifying taxpayers who buy new motor vehicles between February 17 and December 31, 2009.

You can deduct state and local sales taxes and excise taxes paid on up to $49,500 of the purchase price of each qualifying vehicle. To qualify, new cars, trucks or motorcycles must weigh 8,500 pounds or less.

There are income limits for eligibility. Ask your tax adviser for all the details.