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How the PATH Act changed planning for 2016 and beyond

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Just before the end of 2015, Congress passed an appropriations act, which includes the much anticipated extenders bill. That extenders bill — we get one just about every year — is officially known as the Protecting Americans from Tax Hikes (PATH) Act of 2015.

The PATH Act is, perhaps, the most significant extender’s bill in recent memory, because it “permanently” extended several key tax provisions, included the qualified charitable distribution (QCD) provision.

But that’s not all. Stuffed into the bill under a section appropriately titled “Miscellaneous Provisions” are several other changes to the tax law that have nothing to do with the extenders, but that advisors must be aware of to help properly guide their clients for 2016 and beyond. Key changes include the following:

  • Rollovers are now allowed into SIMPLE IRAs after a two-year holding period.

  • The age 50 exception has been further expanded.

  • Certain individuals now have more time to roll over certain airline payment amounts.

  • Several improvements to 529 accounts.

QCDs are back…“forever”

The PATH Act reinstated qualified charitable distributions (QCDs) retroactively to January 1, 2015. Thus, clients who early in 2015 “made QCDs” (that weren’t actually QCDs at the time) under the expectation that Congress would reinstate the provision retroactively (as Congress has done every other time it’s expired in the past) were able to breathe a sigh of relief.

Frankly, the reinstatement was not much of a surprise; and we encouraged charitably inclined eligible persons to make QCDs throughout the year.

What was a surprise, however, was that the PATH Act permanently reinstated QCDs. Of course, when it comes to tax law, the term “permanent” is somewhat of a misnomer. The term just means there is no phase-out date; the tax law remains until Congress passes other legislation to override it. Thus, for the foreseeable future, clients will not have to wait until mid-December — or later — to get tax certainty in respect to QCDs. Thank you Congress!

Here are critical QCD rules you should be familiar with. They:

  • Apply to IRA owners or beneficiaries who are actually age 70½ or over on the date of the distribution.

  • Are capped at $100,000 per person, per year, and count towards client’s required minimum distributions (RMDs).

  • Must be made via direct transfer or check made payable to the charity.

  • Disqualify split-interest interest gifts.

  • May only be made from the taxable portion of IRAs, Roth IRAs and inactive SEP and SIMPLE IRAs.

  • Exclude a client’s income from the IRA distribution, though a deduction may be taken.

  • Require the contribution to the charity be entirely deductible if it were not made from an IRA. There can be no benefit back to the taxpayer.

  • Make applicable the charitable substantiation requirements.

Enhanced Retirement Plan Portability

Beginning in 2001, with The Economic Growth and Tax Relief Reconciliation Act (EGTRRA 2001), there’s been a real push for the increased portability of retirement plans. Up until this point, SIMPLE IRA accounts have pretty much been the lone hold-out.

Frankly, SIMPLE IRA accounts are subject to some weird rules, and up until the PATH Act, one of them was that no non-SIMPLE IRA money could ever be rolled into a SIMPLE IRA.

Now, after a two-year holding period — beginning when the first SIMPLE IRA contributions are received — non-SIMPLE IRA money will be allowed to be rolled into a SIMPLE IRA account. This change could benefit clients if, for instance, their current employer offers a SIMPLE IRA and they’d like to consolidate accounts.

Age 50 exception to the 10% penalty

In the summer of 2015, Congress passed legislation expanding the age 50 exception to include not just state and local public safety workers, but also a host of federal public safety officials. With the passing of the PATH Act, the list of potential occupations that qualify for the exception is further expanded. As a result of the PATH Act, the following categories of workers will also be eligible to utilize the age 50 exception:

  • Certain nuclear materials couriers (yes, that’s a real thing that is specifically defined elsewhere in the tax code)

  • Members of the U.S. Capitol Police (who had to be wondering why they had been left out of the previous expansion by the very people they protect)

  • Members of the Supreme Court Police

  • Diplomatic security special agents of the Department of State

As of January 1, 2016, these individuals, like all other eligible classes of public safety workers, are able to take penalty-free distributions from both their governmental defined benefit plans AND their governmental defined contribution plans as long as they separate from service in the year they turn 50 or later.

More time to roll over bankrupt airline payments

Do you have clients or prospects that were participants in the American Airlines pension plan when it filed for bankruptcy? If the answer is no, then unless you’re just “Jonesing” to learn about one of the more oddball retirement provisions in the entire tax code, you can skip this section. If you do — or you know someone who does — you might look like a hero if you can tell them about this wrinkle in the law.

Eligible clients now have 180 days from the date of receipt of certain payments or, more importantly, 180 days from the signing of the bill (if longer) to rollover qualifying payments of bankrupt airlines. Why American Airlines pension plan participants specifically? Well, while the law doesn’t explicitly state “American Airlines,” it does reference airlines that “filed [for bankruptcy] on November 29, 2011.” Needless to say, that’s a fairly limited class of companies.

Qualifying employees who receive qualifying payments can roll any or all of the payments over into a Roth IRA (as a taxable Roth conversion) within the 180-day window. Conversely, they may roll anywhere up to 90 percent of the payments over to a traditional IRA (as a tax-free rollover) within the same time frame.

529 Plan Improvements

Congress finally caught up with the times and realized that in today’s world, a computer is a requirement for virtually every college student. Believe it or not, prior to the PATH Act, computers were not considered qualified education expenses unless they were explicitly required for a class.

Now, however, computers are considered qualified education expenses, along with peripheral equipment (think mouse, screen, keyboard, etc.), software and even internet access expenses, as long as they used primarily by the student during any of the years they are enrolled. This change was effective for 2015, so any clients who incurred such expenses last year and took 529 distributions should be sure to make certain their tax-preparer correctly records distributions attributable those items tax-free.

Another key change made by the PATH Act is the elimination of the 529 aggregation rule. Up until now, 529 plans have been subject to an aggregation rule similar to the pro-rata rule for IRAs; all 529 plan accounts of the same beneficiary (child/student) have been looked at as one giant 529 account. The PATH Act eliminates this requirement, essentially treating each 529 plan account as its own contract.

Notably, when taking distributions for qualified higher education expenses, it would behoove advisors and their clients to first draw from 529 plans with the greatest percentage of growth relative to contributions (the greatest percentage of gain). By doing do, clients will reap the greatest tax benefit by having the greatest portion of earnings used tax and penalty free for qualified expenses.

Conversely, if a distribution is going to be used to pay for non-qualified expenses, it would make sense to tap the 529 account with the least amount of gain relative to contributions. This way, the smallest possible percentage of the distribution will consist of earnings, which would generally be taxable and subject to a 10% penalty, while the greatest portion will represent a tax and penalty-free return of contributions.

Read also these articles by Jeffrey Levine:

3 IRA annuity RMD traps you must avoid

Taking RMDs early in the year: the case for and against

After-tax plan funds following IRS Notice 2014-54: basic rules

5 QLAC questions and answers


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