NEW TAX LAW SIGNED DECEMBER 2010
The 2010 Tax Relief Act recently signed into law by President Obama was sweeping in the benefits provided to the American public. There was at least a little bit for everyone, and certainly a lot more for many. Conceptually, the Tax Relief Act is a continuation of the Bush tax cuts (EGTRRA) of 2001. Most of the provisions expire in 2012 at which time the merits of continued tax cuts will be debated (as will the merits of our elected officials). Courtesy of Commerce Clearing House, I have provided highlights of the new tax laws that are of greatest interest to our clients, both individuals and businesses. Please feel free to call if you have questions. Here’s a list of the issues:
- Individual tax rates
- Capital gains tax
- Education credits
- Educational assistance exclusion
- Student loan interest deductions
- Individual tax extenders
- Charitable contributions made from IRAs
- Alternative minimum tax
- Payroll tax cut
- Energy Incentives
ESTATE, GIFT AND GENERATION SKIPPING TAX
- Estate Tax Compromise
- Option for 2010
- Gift Taxes
- GST Tax
- 100% bonus depreciation
- Section 179 expensing
- Research tax credit
- Work opportunity tax credit
- Business tax extenders
ALL THIS COMES AT A COST
- Cost estimate of the tax law change
1. Individual Tax Rates
The 2010 Tax Relief Act extends all individual rates at 10, 15, 25, 28, 33 and 35 percent for two years, through December 31, 2012.
2. Capital Gains Tax
Qualified capital gains and dividends are taxed at a maximum rate of 15 percent (zero percent for taxpayers in the 10 and 15 percent income tax brackets) for 2010. The 2010 Tax Relief Act continues this treatment for two years, through December 31, 2012.
3. Education Credits
American Opportunity Tax Credit: The 2009 Recovery Act enhanced and renamed the Hope education credit as the American Opportunity Tax Credit (AOTC) for 2009 and 2010. The e 2010 Tax Relief Act extends the AOTC for two years, through December 31, 2012. Also extended are income limitations (the AOTC begins to phase out for single individuals with modified AGI of $80,000 ($160,000 for married couples if filing jointly) and completely phases out for single individuals with modified AGI of $90,000 ($180,000 for married couples filing jointly).
4. Educational Assistance Exclusion
EGTRRA allows employees to exclude up to $5,250 in employer-provided education assistance annually from income and employment taxes. Employers may deduct up to $5,250 annually for qualified education expenses paid on behalf of an employee. This treatment was scheduled to expire after 2010. The 2010 Tax Relief Act extends these provisions for two years, through December 31, 2012
5. Student Loan Interest Deduction
EGTRRA eliminated a 60-month rule for the $2,500 above-the-line student loan interest deduction and expanded the modified AGI range for phase-out. This treatment was scheduled to expire after December 31, 2010. The 2010 Tax Relief Act extends the enhancements for two years, through December 31, 2012.
6. Individual Tax Extenders
The 2010 Tax Relief Act extends a number of temporary individual tax incentives which had expired at the end of 2009. These incentives, known as extenders, are extended for two years (2010 and 2011). Among the individual incentives extended by the new law (not an exhaustive list) are: State and local sales tax deduction, higher education tuition deduction and teacher’s classroom expense deduction
7. Charitable Contributions Made From IRAs
Seniors can make charitable contributions directly from their IRAs. These distributions have two notable characteristics: They count towards required minimum distributions (RMDs) AND they are not included in taxable income (of course, neither is the contribution a deduction).
8. Alternative Minimum Tax
The 2010 Tax Relief Act 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. The 2010 Tax Relief Act increases the exemption amounts for 2010 to $47,450 for individual taxpayers, $72,450 for married taxpayers filing jointly and surviving spouses, and $36,225 for married couples filing separately.
9. Payroll Tax Cut
The 2010 Tax Relief Act reduces the employee-share of the OASDI portion of Social Security taxes from 6.2 percent to 4.2 percent 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 percent on self-employment income up to the threshold.
10. Energy Incentives
The 2010 Tax Relief Act temporarily extends for one or two years a number of energy tax incentives, primarily targeted to businesses. One popular energy incentive for individuals, the Code Sec. 25C residential energy property credit, is extended but with some limitations.
The Code Sec. 25C credit is designed to reward individuals who make energy efficiency improvements to their residences with a tax benefit. Under current law, the credit amount is 30 percent of the sum of expenditures for qualified energy efficiency improvements and property, such as furnaces, water heaters, insulation materials, exterior windows and doors, and other items, for 2009 and 2010 property. The credit under current law is limited to a lifetime maximum credit of $1,500 for 2009 and 2010 property. The 2010 Tax Relief Act extends the Code Sec. 25C credit through 2011. However, the new law returns the credit to $500, its pre-2009 Recovery Act parameters.
Federal Estate, Gift and Generation Skipping Tax
EGTRRA gradually reduced over a period of years and then abolished the federal estate tax for decedents dying in 2010. The pre-EGTRRA estate tax (with a maximum tax rate of 55 percent and a $1 million applicable exclusion amount) was scheduled to be revived after 2010. Additional EGTRRA changes affected the gift and generation skipping transfer (GST) tax.
1. Estate Tax Compromise
The 2010 Tax Relief Act 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 EGTRRA. The maximum estate tax rate is 35 percent with an applicable exclusion amount of $5 million. 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, the 2010 Tax Relief Act eliminates the modified carryover basis rules and replaces them with the stepped up basis rules that had applied until 2010. Property with a stepped-up basis receives a basis equal to the property’s fair market value on the date of the decedent’s death (or on an alternate valuation date). Under a modified carryover basis that EGTRRA had put into place for 2010, the executor may increase the basis of estate property only by a total of $1.3 million, with other estate property taking a carryover basis equal to the lesser of the decedent’s basis or the fair market value of the property on the decedent’s death. An executor may increase the basis of assets passing to a surviving spouse by an additional $3 million (for a total of $4.3 million).
2. Option for 2010
The 2010 Tax Relief Act 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 a $5 million applicable exclusion amount, with stepped-up basis or (2) no estate tax and modified carryover basis rules under EGTRRA. Any election would be revocable only with the consent of the IRS.
EXAMPLE. Caleb, who is unmarried, died on September 30, 2010. Caleb’s estate is valued at $15 million. Caleb’s estate can elect not to have the revived estate tax apply (with a maximum estate tax rate of 35 percent and a $5 million applicable exclusion amount). If Caleb’s estate makes this election, the estate would not be subject to the estate tax, and the carryover basis rules under EGTRRA would apply.
The 2010 Tax Relief Act provides for “portability” between spouses of the estate. Tax 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.
IMPACT. With the election and careful estate planning, married couples can effectively shield up to $10 million from 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).
4. Gift Taxes
For gifts made in 2010, the 2010 Tax Relief Act provides that gift tax is computed using a rate schedule having a top tax 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.
COMMENT. Donors of lifetime gifts continue to be able to apply the annual gift tax exclusion before having to use part of their applicable exclusion amount. For 2010 and 2011, that inflation-adjusted annual exclusion amount is $13,000 per donee (married couples may continue to “split” their gift and may make combined gifts of $26,000 to each donee).
5. GST Tax
The 2010 Tax Relief Act provides a $5 million exemption amount for 2010 (equal to the applicable exclusion amount for estate tax purposes) with a GST tax 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).
1. 100 Percent Bonus Depreciation
The 2010 Tax Relief Act boosts 50-percent bonus depreciation to 100-percent for qualified investments made after September 8, 2010 and before January 1, 2012. The 2010 Tax Relief Act also makes 50-percent 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-percent expensing if placed in service before January 1, 2013.
IMPACT. 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.
COMMENT. Bonus depreciation is not limited by the size of a taxpayer’s investments 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.
2. Code Sec. 179 Expensing
Congress has repeatedly increased the dollar and investment limits under Code Sec. 179 to encourage business spending. The 2010 Small Business Jobs Act increased the Code Sec. 179 dollar and investment limits to $500,000 and $2 million, respectively, for tax years beginning in 2010 and 2011. The 2010 Tax Relief Act provides for a $125,000 dollar limit (indexed for inflation) and a $500,000 investment limit (indexed for inflation) for tax years beginning in 2012 (and sun setting after December 31, 2012). The 2010 Tax Relief Act also extends the treatment of off -the-shelf computer software as qualifying property if placed in service before 2013.
3. Research Tax Credit
The Code Sec. 41 research tax credit expired at the end of 2009. The 2010 Tax Relief Act renews the credit for two years, through December 31, 2011 and is effective for amounts paid or incurred after December 31, 2009.
4. Work Opportunity Tax Credit
The Work Opportunity Tax Credit (WOTC) is intended to encourage employers to hire individuals from targeted groups. The WOTC is equal to 40 percent of up to $6,000 of the targeted employee’s qualified first-year wages, subject to certain requirements and limitations. The WOTC was scheduled to expire after August 31, 2011. The 2010 Tax Relief Act extends the WOTC for individuals who begin employment after August 31, 2011 and before January 1, 2012, but with some modifications.
5. Business Tax Extenders
The 2010 Tax Relief Act extends a number of business tax extenders, which had expired at the end of 2009. These business tax extenders are generally extended for two years: 2010 and 2011. Notable business tax incentives extended by the 2010 Tax Relief Act are 15-year recovery periods for qualified leasehold improvements, restaurant building and improvements, and retail improvements
ALL THIS COMES AT A COST
Here’s the estimate:
2010 TAX RELIEF ACT REVENUE COST
|Individual Tax Cuts
|Payroll Tax Deduction
|Estate/Gift Tax Relief
|Capital Gains/ Dividend Cuts
|Bonus Depreciation/179 Expensing
|Total Cost of Tax Provisions
*$857 billion total cost of law includes $56 billion for unemployment insurance extension.