The extension of the lower income and capital gains tax rates set to expire Dec. 31, along with significant reductions to the estate tax, has probably received the most media coverage. But the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, passed by the Senate Dec. 15 and the House Dec. 16, extends and expands a wide variety of valuable tax breaks.
Many of the breaks were set to expire after 2010 under the “sunset” provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 and have now been extended through 2012. Other breaks expired at the end of 2009 and have been extended only through 2011. But they’ll provide welcome relief for many taxpayers when they file their 2010 returns.
Finally, the 2010 Tax Relief act provides a few new tax breaks, most notably a payroll tax reduction for 2011.
Payroll tax rates
For 2011 only, the 2010 Tax Relief act reduces the employee portion of the Social Security tax on earned income from 6.2% to 4.2%. The self-employed pay both the employee and employer portions of Social Security tax, and the Tax Relief act also reduces their rate by two percentage points for 2011, from 12.4% to 10.4%.
For 2011, the maximum taxable wage base for Social Security taxes is $106,800 (the same as for 2010). So the maximum tax savings from this break is $2,136.
Ordinary income tax rates
Because of the 2001 tax act sunset, ordinary income tax rates (except for the 15% rate) were scheduled to increase for 2011. There was much talk about extending the lower rates for only the lower and middle tax brackets or for only one year, but the 2010 Tax Relief act extends the lower rates for all brackets for two years. Furthermore, the size of the 15% tax bracket for joint filers and qualified surviving spouses will remain at 200% of the 15% tax bracket for individual filiers (instead of dropping to 167%). So income tax rate increases now aren’t scheduled to occur until 2013:
|Ordinary income tax rates|
Tip: If you’ve been planning to accelerate income into 2010 to take advantage of lower tax rates, such a step is no longer necessary. Rather, you may want to defer income to 2011 to defer the tax liability.
Long-term capital gains rates
Under the 2001 tax act, the 15% long-term capital gains rate was scheduled to increase to 20% in 2011. The 2010 Tax Relief act extends the 15% rate through 2012. If you have children or other loved ones in one of the bottom two ordinary income tax brackets, note that the 0% rate will generally apply to their long-term gains through 2012. (Beware of the “kiddie” tax, however.)
Tip: If you’ve been considering selling appreciated assets by year end to take advantage of the 15% rate, you now can hold off until 2011 or even 2012. Of course, if a sale will help you achieve other goals, you shouldn’t hesitate simply because there’s no longer a tax reason to sell this year.
Qualified dividend tax rates
The 2010 Tax Relief act extends taxation of qualified dividends at the 15% long-term capital gains tax rate through 2012 (0% for those in the bottom two brackets). Without Congressional action, dividends would have gone back to being taxed at ordinary income rates in 2011, with a top rate as high as 39.6%.
Tip: If you hold dividend-producing investments and have been considering whether you should make adjustments to your portfolio in light of their potentially higher tax cost, you no longer need to worry about making a decision before year end.
Tax-free IRA distributions to charity
The 2010 Tax Relief act extends the provision that permits taxpayers age 70 ½ or older to make tax-free distributions to charity from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer, per tax year. This provision is retroactively reinstated for 2010 and extended through 2011. Furthermore, individuals will be allowed to treat IRA transfers to charities during January 2011 as if such distributions were made during 2010.
Increased exclusion on small business stock gains
To make investing in certain small businesses more attractive, the Small Business Jobs Act of 2010 (SBJA), signed into law in September, temporarily increased the qualified small business (QSB) stock gain exclusion to 100% for stock acquired after Sept. 27, 2010, and before Jan. 1, 2011, that’s held for at least five years. Additionally, the SBJA eliminated the alternative minimum tax (AMT) preference item on such gain, making it tax free for AMT purposes as well. The 2010 Tax Relief act extends the acquisition deadline for 100% gain exclusion and elimination of the AMT preference item to Dec. 31, 2011.
Tip: QSB stock can help diversify your portfolio while providing additional potential tax benefits. So purchasing it by the end of 2011 may be worth considering. (To be a QSB, the company can’t hold gross assets exceeding $50 million at the time the stock is issued and must be engaged in an active trade or business.)
Itemized deduction and personal exemption phase-outs
The 2001 tax act reduced the adjusted gross income (AGI)-based reductions on itemized deductions and personal exemptions for 2006 through 2009 and eliminated them for 2010. The 2010 Tax Relief act extends this elimination through 2012.
Tip: If you’ve been planning to accelerate deductions into 2010 to take advantage of elimination of the phase-out, such a step is no longer necessary. However, accelerating deductible expenses into the current tax year is often a smart strategy, because it defers tax. So you may want to do so anyway. But beware of the AMT.
Deduction for state and local sales taxes
For the last several years, taxpayers have been allowed to take an itemized deduction for state and local sales taxes in lieu of state and local income taxes. This break can be valuable to those residing in states with no or low income tax rates or who purchase major items, such as a car or boat. But this break expired after 2009.
Now the 2010 Tax Relief act has extended it for 2010 and 2011 (but not for 2012).
Dependent care credit
The 2001 tax act increased the maximum amount of eligible expenses for the dependent care credit from $2,400 to $3,000 for one qualifying dependent and from $4,800 to $6,000 for more than one qualifying dependent through 2010. The 2010 Tax Relief act extends these higher limits through 2012.
The maximum credit is generally 20% of eligible expenses, which is $600 for one dependent and $1,200 for more than one dependent. There’s no upper AGI limit for claiming the credit, but taxpayers with AGIs of $43,000 or less are eligible for a larger maximum credit.
The AMT is a separate tax system that limits some deductions and credits, doesn’t permit others and treats certain income items differently. If your AMT liability is greater than your regular tax liability, you must pay the AMT.
Unlike the regular tax system, the AMT system isn’t regularly adjusted for inflation. Instead, Congress must legislate any adjustments. Typically, it has done so in the form of a “patch” — an increase in the AMT exemption. The 2010 Tax Relief act establishes patches for 2010 and 2011:
| ||AMT exemption|
|Single or |
Head of household
|Married filing jointly|
or surviving spouse
Note: Consult your tax advisor for AMT exemptions for children subject to the kiddie tax.
For 2010 and 2011, the Tax Relief act also allows you to offset your AMT liability with certain nonrefundable personal credits (such as the dependent care credit and certain energy-related credits) you’re otherwise eligible for.
An expansive act
We’ve been focusing on provisions that will help higher-income taxpayers to reduce their individual income tax liability. But the 2010 Tax Relief act provides many additional opportunities:
- If you have loved ones in the middle or lower tax brackets, they may benefit from extensions of breaks that you won’t qualify for, such as various education- and child-related credits and deductions.
- If you’re a business owner or executive, there are many business breaks that could reduce your business’s taxes (and your own, if you’re an owner of a flow-through entity).
- If estate taxes are a concern, you’ll want to review your estate plan in light of the Tax Relief act’s temporary estate tax relief.
- If you’re interested in reducing energy consumption, you may want to take advantage of extensions of various energy-related breaks.
- If you’re currently unemployed, you may benefit from the act’s extension of unemployment benefits.
If you’d like to learn more about any of these provisions and how they might affect your situation, please contact us. We’d be pleased to help you take full advantage of the opportunities the 2010 Tax Relief act offers.