TAX UPDATE | January 2011

Congress recently passed H.R. 4853, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (The 2010 Act) and there are a number of important points to understand. The 2010 Act contains several tax cuts, including a two-year extension of the Bush-era tax cuts, estate tax relief, extension and enhancement of a number of business and individual tax breaks, a two-year alternative minimum tax (AMT) “patch,” and a 2% payroll/self-employment tax cut for 2011 for employees and self-employed individuals.

EGTRRA (Bush-era) Tax Cuts Extended for Two Years

The provisions of the Economic Growth & Tax Relief Reconciliation Act that reduced the Federal income tax rates for individual taxpayers sunset, and thus would not apply for tax years beginning after December 31, 2010. The 2010 Act postpones the sunset rule for two years, thus extending the lower marginal tax rates through the end of 2010. The individual income tax rates will remain at 10%, 15%, 25%, 28%, 33% and 35% (instead of reverting to the 15%, 28%, 31%, 36% and 39.6%).

Furthermore, the EGTRRA increased the standard deduction for married couples filing a joint return to twice the standard deduction for single taxpayers. This provision, under current law, was scheduled to sunset, and revert back to 167% of the standard deduction for single taxpayers for tax years beginning after 2010. In addition, EGTRRA eliminated the phase-out of high-income taxpayers’ personal exemptions.

The 2010 Act also delays the sunset provision by one year, thus allowing married taxpayers filing a joint return to claim a standard deduction equal to 200% of the standard deduction for single taxpayers for 2011; and extended the elimination of the phase-out of high-income taxpayers’ personal exemptions.

Capital Gains & Qualified Dividends

The 2010 Act extends, for two years (through 2012), the 15% rate for long-term capital gains and qualified dividends. Absent this provision, most long-term capital gains would have reverted back to 20% and dividends to ordinary income tax rates.

Business Incentives for Investment

The Tax Relief Act of 2010 enacts the following new provisions:

• A 100% bonus first-year depreciation allowance for property placed in service after September 8, 2010, and before January 1, 2012;
• A 50% bonus first-year depreciation allowance for property placed in service after December 31, 2011, and before December 31, 2013; and
• For tax years beginning after December 31, 2011, enacting the maximum Code Section 179 amount at $125,000, setting the phase-out amount at $500,000.

In addition, the provision to elect to accelerate the Alternative Minimum tax credit in lieu of claiming bonus depreciation is extended through December 31, 2012.

Alternative Minimum Tax “Patched” for Two Years
The AMT exemption amounts are not permanently indexed for inflation. Thus, without Congressional action, millions of additional taxpayers would unintentionally fall subject to the AMT. Without the “patch” the AMT exemption amounts would have plunged to pre-2001 levels. For 2010, the AMT exemption amounts would have dropped to $45,000 for married taxpayers filing a joint return and surviving spouses, $33,750 for single taxpayers, and $22,500 for married individuals filing separately.

Under the 2010 Act, the AMT exemption amounts are increased and indexed for inflation for both 2010 and 2011.

The 2010 Act increases the AMT exemption amounts for 2010 as follows:

• Married individuals filing jointly and surviving spouses: $72,450, less 25% of AMTI exceeding $150,000 (zero exemption when AMTI is $439,800);

• Single individuals: $47,450, less 25% of AMTI exceeding $112,500 (zero exemption when AMTI is $302,300); and

• Married individuals filing separately: $36,225, less 25% of AMTI exceeding $75,000 (zero exemption when AMTI is $219,900). But AMTI is increased by the lesser of $36,225 or 25% of the excess of AMTI (without the exemption reduction) over $219,900.

Further, the 2010 Act increases the AMT exemption amounts for 2011 as follows:

• Married individuals filing jointly and surviving spouses: $74,450, less 25% of AMTI exceeding $150,000 (zero exemption when AMTI is $447,800);

• Single individuals: $48,450, less 25% of AMTI exceeding $112,500 (zero exemption when AMTI is $306,300); and

• Married individuals filing separately: $37,225, less 25% of AMTI exceeding $75,000 (zero exemption when AMTI is $223,900). But AMTI is increased by the lesser of $37,225 or 25% of the excess of AMTI (without the exemption reduction) over $223,900.

Whittlesey & Hadley Observation: As in the past, different amounts apply for children subject to the kiddie tax for both 2010 and 2011.
In addition, for 2010 and 2011, many non-refundable personal credits will be allowed against the AMT. Without this “patch,” these individual non-refundable credits would be subject to an AMT floor.

Research Credit Extended Two Years

The 2010 Act retro-actively reinstates the research credit for expenditures incurred after December 31, 2009, but before December 31, 2011.

Temporary 2011 Payroll Tax Cut for Employees

Under current law, employees are required to pay Social Security (payroll) tax of 6.2% on all 2011 wages earned up to $106,800. Self-employed individuals pay 12.4% Social Security (self-employment) tax on all 2011 wages earned up to $106,800.

The 2010 Act enacts a payroll/self-employment tax holiday for 2011 to the tune of 2%. Employees will only pay 4.2% social security tax on wages and self-employed individuals will only pay 10.4% social security tax. Moreover, the threshold of $106,800 remains unchanged.

Business Tax Breaks Extended Retro-actively

In addition to the research tax credit, a host of other business tax breaks were retro-actively reinstated through 2011. Those provisions include:

• The new markets tax credit;
• Employer wage credit for activated reservists;
• The Indian employment tax credit;
• The work opportunity tax credit (WOTC);
• 15-year write off for qualified leasehold improvements, restaurant buildings and improvements, and retail improvements;
• 7-year write off for motorsports entertainment facilities;
• Empowerment zone tax incentives;
• Enhanced charitable deductions for contributions of food inventory, book inventories to public schools, and computer equipment for educational purposes;
• Expensing of environmental remediation costs; and
• A host of energy extenders.

Individual Tax Breaks Extended Retro-actively

Numerous tax breaks for individuals expired at the end of 2009. The Act reinstates the following provisions through 2011:

• The $250 above-the-line deduction for school teachers
• The above-the-line deduction for qualified tuition and related expenses
• The election to claim, as itemized deductions, state and local sales taxes in lieu of state and local income taxes
• Increased contribution limits and carryforward period for contributions of appreciated real property for conservation purposes
• Tax-free distributions from individual retirement plans for charitable purposes

In addition, the Act extends for one year (through 2011) the provision allowing mortgage insurance premiums to be deductible as mortgage interest on a qualified residence.

Estate Tax Relief

EGTRRA phased-out the estate and generation-skipping taxes, ultimately repealing them in 2010; lowered the gift tax rate to 35%, and increased the gift tax exemption to $1 million for 2010.
The 2010 Act increased the exemption to $5 million per person ($10 million per couple) and enacts a top estate, gift and generation-skipping tax rate of 35% through 2012, indexing after 2012.

The 2010 Act’s changes are effective on January 1, 2010. However, for estates arising on or after January 1, 2010 and before January 1, 2011, executors may elect to choose no estate tax and modified carryover basis. Further, for 2010, a $5 million generation-skipping transfer tax exemption and zero percent rate is applicable.

In addition, the exclusion amount is increased by the unused portion of a spouse’s exclusion amount. That is, any portion of the $5 million exemption amount can be transferred and used by the surviving spouse.

The 2010 Act also unifies the estate and gift taxes for gifts made after December 31, 2010.