Year-End Tax Deal Eliminates Stretch IRAs Along With Other Changes

Congress has passed year-end funding legislation that includes a significant number of tax provisions. The Further Consolidated Appropriations Act, 2020 (H.R. 1865), which is expected to receive President Donald Trump’s signature, alters retirement plan rules, continues several credits and other expired or soon-to-expire tax provisions, and offers additional relief to taxpayers impacted by a disaster. The measure also provides tax relief to certain tax-exempt entities and repeals three taxes under the Affordable Care Act.

The legislation falls short of remedying some of the most important glitches taxpayers have been struggling with since the Tax Cuts and Jobs Act (TCJA) was enacted in 2017. For instance, the measure does not fix the so-called retail glitch, under which qualified improvement property placed in service after December 31, 2017 is ineligible for bonus depreciation.

IRA Reform

The legislation makes several changes to retirement plans and savings vehicles that impact both individuals and businesses. It raises the age for required minimum distributions for IRA account owners to age 72 from age 70.5 and eliminates the maximum age for contributing to an IRA, which is now set at 70.5.

The measure also shortens the time period by which those who inherit a 401(k), IRA or Roth IRA must completely withdraw the funds. The minimum distribution rules in effect before the legislation allowed the beneficiaries of these retirement accounts to stretch distributions over a lifetime, commonly known as a stretch IRA. The legislation eliminates stretch IRAs by requiring that the entire balances from these inherited accounts be withdrawn within 10 years.

Exceptions to this rule apply to a surviving spouse or minor child of the retirement account owner. However, a minor child would be required to withdraw the entire balance of the account within 10 years after reaching the age of majority as determined under state law. The new law applies to distributions with respect to account holders who die after December 31, 2019.

The legislation also allows taxpayers to withdraw up to $5,000 from their retirement accounts in the year following the birth or adoption of a child without incurring a 10% early withdrawal tax.

Provisions impacting employers:

• allow two or more companies in different industries to form a pooled plan to offer defined contribution plans or IRAs to their employees,
• require companies to include long-term part-time workers in 401(k) plans, and
• increase a tax credit for small employer pension startup costs and offer a credit for small employer plans that adopt automatic enrollment.

Kiddie-Tax Fix

The legislation also repeals a kiddie-tax provision under the TCJA so that children’s unearned income is not taxed at rates applicable to trusts. Instead the child’s income is taxed at their parents’ top marginal rates, as was the case before the TCJA was enacted. The TCJA’s change to the kiddie-tax rule was intended to discourage tax-motivated transfers of investment income to minor children. However, the provision ended up ensnaring survivor’s benefits paid to children of deceased military parents and other unearned income received by children in less affluent families, leading them to face higher taxes than they did prior to the TCJA.

Tax-Exempt Organizations

The measure provides relief to certain tax-exempt organizations. It reduces the tax rate to 1.39%, from 2% on the net investment income of tax-exempt private foundations. The legislation repeals a provision contained in the TCJA allowing the rate to be reduced to 1% if the foundation meets certain distribution requirements. The change applies to taxable years beginning after the date of the legislation’s enactment.

The legislation repeals the so-called Church Parking Tax, which was enacted under the TCJA. The 2017 law classified transportation, parking, and athletic center benefits provided by tax-exempt organizations to their employees as fringe benefits. Those amounts were taxed as unrelated business income at a rate of 21% under the 2017 law. The measure is retroactive to the 2017 law’s enactment.

Tax Extenders

The legislation continues several tax credits or other provisions that were soon-to expire or expired impacting both individuals and businesses. Some highlights for individual taxpayers, include the extension of the following provisions from 2018 through 2020:

• the exclusion of discharged mortgage debt from gross income,
• the treatment of mortgage insurance premiums as mortgage interest for purposes of the mortgage interest deduction, and
• temporary lowering to the floor for the medical expense deduction through 2020 allowing individuals to deduct unreimbursed medical expenses greater than 7.5% of their adjusted gross income (AGI), instead of 10%.

Key extensions for businesses include:

•  the subpart F look-through rule for certain transactions between related controlled foreign corporations from January 1, 2020 to January 1, 2021,
• the New Markets Tax Credit from 2019 to 2020,
• an election to treat as much as $15 million in certain film, television, and theater costs — or $20 million in certain economically disadvantaged areas — as a deductible expense from December 31, 2017 to December 31, 2020,
• the credit for producing biodiesel fuel from December 31, 2017 to December 31, 2022, and
• the credit for producing wind energy from January 1, 2020 to January 1, 2021.

Elimination of Affordable Care Act Taxes

The legislation permanently repeals three taxes imposed under the Affordable Care Act. The Cadillac tax on high-cost employer health plans, was scheduled to take effect in 2022 and would have applied to employer-sponsored health plans that in that year cost more than $10,200 for individuals and $27,500 for families. The 2.3% tax on medical devices would have applied to items such as hip implants. Also eliminated under the legislation is an annual fee on health insurance providers.

Disaster Relief

The legislation also offers various forms of tax relief to individuals and businesses affected by a major disaster declared in the period from January 1, 2018, through the 60th day after the measure’s enactment. Among other things, the measure allows individuals to:

• take temporary withdrawals or loans of as much as $100,000 from their retirement accounts without penalty and treat such withdrawals as a tax-free rollover if repaid within three years,
• take an extra year to pay back loans that were outstanding before the major disaster, and
• recontribute unused withdrawal amounts intended to repair or replace a home in a disaster area.

The Takeaway

The legislation alters retirement plan rules, continues several credits and other expired or soon-to-expire tax provisions, and offers additional relief to taxpayers impacted by a disaster. The measure also provides tax relief to certain tax-exempt entities and repeals three taxes under the Affordable Care Act. The legislation does not include any tax technical corrections from the TCJA, and the timing of any technical corrections legislation remains uncertain.