On December 17, 2010 President Obama signed into law a multi-billion dollar tax cut package – the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 TRA”). The 2010 TRA extends the Bush-era individual and capital gains/dividend tax cuts for all taxpayers for two years. The bill also provides for an AMT “patch,” a one-year payroll tax cut, 100 percent bonus depreciation through 2011 and 50 percent bonus depreciation for 2012, and extends various energy credits, among other provisions.
The new law gives taxpayers some certainty in tax planning for the next two years, especially concerning the individual income tax rates, capital gains/dividend tax rates, and the estate tax. However, the provisions are temporary and the ultimate fate of the Bush-era tax cuts is deferred until after 2012, a presidential election year. For most individuals, the most immediate impact of the new law will be the payroll tax cut and the extension of the reduced personal income tax rates.
Individual Tax Rates
The 2010 TRA extends through December 31, 2012 all individual rates. An estimate of the 2011 tax brackets:
Tax Rate Single Persons Taxable Income Married Filing Joint Taxable Income
10% Under $8,500 Under $17,000
15% $8,501 to $34,500 $17,001 to $69,000
25% $34,501 to $83,600 $69,001 to $139,350
28% $83,601 to $174,400 $139,351 to $212,300
33% $174,401 to $379,150 $212,301 to $379,150
35% Over $379,150 Over $379,150
Combined with the payroll tax cut discussed below, the extension of the individual rate cuts will give many individuals a significant increase in immediate dollars available to them in 2011 over what would have resulted without a tax bill.
Qualified capital gains and qualified dividends are taxed at a maximum rate of 15%, with a 0% rate for taxpayers in the 10 and 15% income tax brackets for 2010. The 2010 TRA continues this treatment for two years through December 31, 2012. Without the 2010 TRA, the maximum rate on net capital gains had been scheduled to rise to 20% in 2011, and the rate on qualified dividends also would have risen from 15% to the tax rates on regular income that threatened to reach as high as 39.6%. The 2010 TRA also extends the 100% exclusion of gain realized from qualified small business stock held for more than five years.
Qualified dividends, which continue to be eligible for the reduced tax rates, are dividends received from a domestic corporation or a qualified foreign corporation, on which the underlying stock is held for at least 61 days within a specified 121 day period.
Itemized Deduction Limitation
The “Pease” limitation (named after the member of Congress who sponsored the bill enacting it) has in recent years caused a “phase-out” of itemized deductions for higher-income individuals on expenses like property taxes, home mortgage interest and charitable contributions. The Pease limitation was repealed during 2010, but was scheduled to reappear in 2011. The 2010 TRA extends full repeal of the Pease limitation for two more years, through December 31, 2012.
Personal Exemption Phaseout
Before 2010, taxpayers with incomes over certain thresholds were subject to the personal exemption phaseout (PEP). The PEP reduced the total amount of exemptions that may be claimed where the taxpayer’s adjusted gross income exceeded certain limits, projected for 2011 to start at $169,550 for singles and $254,350 for joint filers. The 2010 TRA extends repeal of the PEP for two years, through December 31, 2012.
The Joint Committee on Taxation estimates that higher-income taxpayers will save over $20 billion from the combined itemized deduction and personal exemption provisions in the new law.
Alternative Minimum Tax
The 2010 TRA provides an AMT “patch” intended to prevent the AMT from encroaching on middle income taxpayers by providing higher exemption amounts and other targeted relief for 2010 and 2011. Without this patch, which had expired at the end of 2009, an estimated 21 million additional households would be subject to the AMT.
Payroll Tax Cut
The 2010 TRA reduces the employee-share of the FICA portion of Social Security taxes from 6.2% to 4.2% for wages earned during the payroll tax holiday period (calendar year 2011) up to the taxable wage base of $106,800.
Self-employed individuals will pay 10.4% on self-employment income up to the threshold. The new payroll tax holiday period is estimated to inject over $110 billion into the economy in 2011. The 2% FICA reduction is available to all wage earners, with no phase out limit irrespective of income level. Thus, individuals earning at or above the FICA cap of $106,800 will receive a $2,136 tax benefit in 2011.
Self-employed individuals under the Tax Relief Act would calculate the deduction for employment taxes without regard to the temporary rate reduction (that is, one-half of 15.3 % of self-employment income). However, the 2010 TRA provides an enhanced percentage representing the employer portion of the deduction.January 27, 2011
100 Percent Bonus Depreciation
The 2010 TRA (Tax Relief Act) boosts 50% bonus depreciation to 100% for qualified investments made after September 8, 2010 and before January 1, 2012. The 2010 TRA also makes 50% bonus depreciation available for qualified property placed in service after December 31, 2011 and before January 1, 2013. Certain long-lived property and transportation property is eligible for 100% depreciation if placed in service before January 1, 2013. This provision is one of the most expansive for businesses. Unlike Code Sec. 179 expensing, it is not limited to use by smaller businesses or capped at a certain dollar level.
The 2010 Small Business Jobs Act also increased the Code Sec. 179 dollar and investment limits to $500,000 and $2 million respectively, for tax years 2010 and 2011. The new law provides for Code Sec. 179 expensing at a level of $125,000 for 2012. Bonus depreciation is not limited by the size of a taxpayer’s investment in qualified property and it can generate net operating losses. Bonus depreciation, however, applies only to new property and is not exempt from certain uniform capitalization rules as is small business expensing.
Small Business Stock
The 2010 Small Business Job Act enhanced the exclusion of gain from qualified small business stock to non-corporate taxpayers. For stock acquired after September 27, 2010 and before January 1, 2011, and held for at least five years, the 2010 Small Business Jobs Act provided an exclusion of 100%. The 2010 TRA extends the 100% exclusion for one more year, for stock acquired before January 1, 2012. With the 100% exclusion, none of the gain on qualifying sales or exchanges of small business stock is subject to federal income tax. In addition, the excluded gain is not treated as a tax preference item for AMT purposes, so none of the gain will be subject to AMT. Investors, however, must be patient to realize this benefit because they must hold the qualified shares for at least five years (or rollover proceeds to other qualified shares).
Certain baseline requirements for the exclusions continue to apply:
– To qualify as small business stock, the stock must be issued by a C corporation that invests 80% of its assets in the active conduct of a trade or business and that has assets of $50 million or less when the stock is issued.
– Qualified stock must be held for more than five years (rollovers into other qualified stock are allowed).
– The amount taken into account under the exclusion is limited to the greater of $10 million or ten times the taxpayer’s basis in the stock.
– Any taxpayer, other than a C corporation, can take advantage of the exclusion.
The 2010 TRA temporarily extends for one or two years a number of energy tax incentives, including credits for biodiesel and renewable diesel, new energy-efficient home credit for qualified builders, and extends the credit, but reduces the benefit thereof to pre-2009 levels, for individuals making energy-efficient home improvements.January 27, 2011
Federal Estate Taxes
Some of the biggest news in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 TRA”) involves estate taxes. The federal estate tax changed significantly over the past 10 years, with gradually increasing exemptions from imposition of estate tax rising to $3.5 million dollars per person in 2009. In 2010 the federal estate tax went away for one year, but was poised to return in 2011 at the old rates and exemption amounts (55% and $1 million per person) if no legislation had been passed last December.
The 2010 TRA revives the estate tax for decedents dying after December 31, 2009, but at a significantly higher applicable exclusion amount and lower tax rate than had been scheduled under the old law. The maximum estate tax rate is 35 percent with an applicable exclusion amount of $5 million per person. This new estate tax regime, however, is itself temporary and is scheduled to sunset on December 31, 2012.
Together with the revival of the estate tax, 2010 TRA eliminates the modified carryover basis rules that applied in the absence of an estate tax. Property inherited after 2010 TRA receives a stepped-up basis equal to the property’s fair market value on the date of the decedent’s death (or on an alternate valuation date).
Option for 2010
The 2010 TRA gives estates of decedents dying after December 31, 2009 and before January 1, 2011, the option to elect not to come under the revived estate tax. The new law gives those estates the option to elect to apply (1) the estate tax based on the new 35 percent top rate and $5 million applicable exclusion amount, with stepped-up basis or (2) no estate tax and modified carryover basis rules. Any election would be changeable only with IRS consent.
The 2010 Tax Relief Act provides for “portability” between spouses of the estate tax applicable exclusion amount. Generally, portability would allow a surviving spouse to elect to take advantage of the unused portion of the estate tax applicable exclusion amount of his or her predeceased spouse, thereby providing the surviving spouse with a larger exclusion amount. A “deceased spousal unused exclusion amount” would be available to the surviving spouse only if an election is made on a timely filed estate tax return. Portability would be available to the estates of decedents dying after December 31, 2010. Under the Tax Relief Act of 2010, the portability election will sunset on January 1, 2013.
With the election and careful estate planning, married couples can effectively shield up to $10 million from the estate tax by providing that each spouse maximize his or her $5 million applicable exclusion. Because this provision is scheduled to sunset after 2012, the utility of the portability election is limited to situations where both spouses die with the two-year term (that is, 2011-2012), or if this provision is extended, after 2012.
For gifts made in 2010, the 2010 TRA provides that gift tax is computed using a rate schedule having a top rate of 35 percent and an applicable exclusion amount of $1 million. For gifts made after 2010, the gift tax is reunified with the estate tax with a top gift tax rate of 35 percent and an applicable exclusion amount of $5 million. This “reunification” of estate and gift tax exemption amounts presents tremendous lifetime planning opportunities to preserve family wealth.
Donors of lifetime gifts also continue to be able to use their annual gift tax exclusion before having to use part of their applicable lifetime exclusion exemption. For 2010 and 2011, that inflation-adjusted annual exclusion amount is $13,000 per recipient (married couples may continue to “split” their gift and may make combined gifts of $26,000 to each recipient), to an unlimited number of individual recipients.
The 2010 TRA provides a $5 million exemption amount for 2010 (equal to the applicable exclusion amount for estate tax purposes) with a Generation Skipping Tax (GST) rate of zero percent for 2010. For transfers made after 2010, the GST tax rate would be equal to the highest estate and gift tax rate in effect for the year (35 percent for 2011 and 2012).
State of Washington Estate Taxes
The State of Washington continues to have its own parallel estate tax system to the Federal Estate Tax. The State of Washington will impose an estate tax on the estates of persons resident to Washington with a net worth in excess of $2 million dollars per person. Estate taxes paid to Washington State are deductible for Federal estate tax purposes, but with the higher Federal exemption amounts there will be very few estates that benefit from this deduction. Estate tax rates in Washington range from 15% to 19% of the value of the taxable estate.
Washington residents with the ability to make gifts to family or friends may realize a significant tax savings benefit by making lifetime gifts rather than gifts under a Will or Trust. Gifts made during the gift-maker’s lifetime remove the gift from the gift-maker’s estate for Washington State estate tax purposes, thereby saving the State of Washington estate taxes that may otherwise apply if the gift were transferred at death. With the recent increase to $5 million per person in lifetime giving that can be done without incurring Federal gift tax, there is significant incentive to consider lifetime gifts that result in reduced State of Washington estate taxes in the future.
Charitable Giving and the 2010 Tax Relief Act
In 2011, taxpayers age 70 & ½ or older may make charitable transfers of otherwise taxable distributions from their traditional IRAs and Roth IRAs up to a total of $100,000 per taxpayer, per taxable year. So, rather than adding your required distributions to your taxable income, you can choose to donate those distributions to charity up to $100,000 per year.
Taxpayers were not able to make these tax-free transfers to charity in the 2010 tax year because the relevant tax code provisions expired at the end of 2009. As part of the recent tax law changes, charitable transfers can once again be made directly from an IRA to a charitable organization. While no income tax deduction results from this type of transfer, neither does this transfer cause income recognition to the donor from the IRA distribution.Newer posts →