The 2010 Tax Act We Have All Been Waiting For

December, 2010

Unless you have been buried in WikiLeaks documents about the partners of Williams Benator & Libby, you have certainly heard that right before the Christmas break President Obama signed the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010”.  For the record, the partners did not make up that title as a distraction.  Nevertheless, some expected and not-so-expected provisions came out of the year-end Act that we would like to share with you.

 

“Bush-Era Tax Cuts” Get Extended
The income tax brackets in place in 2010 will continue thru 2012 for all individual taxpayers.  This includes a maximum federal tax rate of 15% for most long-term capital gains and qualified dividends.  See our website for our discussion of tax rates earlier this year atwww.wblcpa.com.

Also extended through 2012 is the repeal of the Personal Exemption Phase-out and the Itemized Deduction Limitation.  This means that upper income taxpayers will enjoy the benefits of more of their itemized deductions and personal exemptions that were severely limited dating back to the 1990s.

The $1,000 child tax credit is back for another two years.  It is still phased out for those with AGI starting at $110,000 ($75,000 for singles).  Also back are enhanced credits for adoptions, dependent care and college education, subject to the same AGI limitations previously in place.

 

The “Extenders”
In the shadow of the provisions noted above, some important tax incentives that expired at the end of 2009 got extended retroactively for 2010 and through 2011.  This included the all-important Alternative Minimum Tax (AMT) “patch”.  The patch temporarily raises the AMT exemption so that an estimated 21 million taxpayers can avoid paying the AMT.  We hope you were one of the 21 million, but chances are if you were in an AMT posture in 2009, you will likely be in it again all other things being equal.

Speaking of AMT, note that the President’s Deficit Commission recommended earlier this month to replace the current tax structure with a “super AMT” with lower tax rates but significantly less deductions allowed.  We will monitor the dialogue and see if such an idea advances once the lobbyists enter the fray.

Other extenders through 2011 of previously expired incentives include: the R&D credit, higher tuition deduction, teacher’s expense deduction, 15-year depreciable lives for certain real estate developments and tax-free distributions from IRAs for charitable purposes.   In addition, certain business energy incentives were extended as well as a popular tax credit for energy efficient home improvements.  But the home improvement credit has been reduced to $500 for 2011.

 

Payroll Tax Surprise
The Act reduces by 2% the employee’s share of Social Security tax payable on wages and self-employment income in 2011.  This can save workers up to $2,136 in 2011 depending on their income.  The Medicare portion of the tax will not change.   And the employer’s share of the tax is unchanged.  This is a one-year holiday.

 

What Good is a Tax Act Without Depreciation Changes?
Not to be outdone by previous Tax Acts, the December legislation introduced an enhanced “bonus” depreciation.  Most business assets bought new after September 8, 2010 and before January 1, 2012 are now eligible for 100% bonus depreciation.  This might sound like the Section 179 expensing election we have all come to know and love, but it is generally better if the acquired assets are bought new because there is no limit on the size of the taxpayer or its investment, and the depreciation expense can generate net operating losses.  For 2012, the bonus depreciation percentage is reduced to 50 percent.

Similar to a rule in place several years back, if you have AMT credit carryovers the Act allows you to elect out of bonus depreciation and instead claim certain refundable AMT credits.

Section 179 is still around for pre-owned business assets acquired in 2010 and 2011.  The expensing limit for those years is $500,000 as long as investment amounts don’t exceed $2 million.  In 2012, the Section 179 deduction is limited to $125,000 as long as investment amounts don’t exceed $500,000.

 

Estate and Gift Clarity – Temporarily
Perhaps the most controversial provisions of the Act relate to estate and gift taxes given the perceived benefits to the “wealthy” that it provides.  Subject to a 2010 option discussed below, the estate tax has been retroactively revived for deaths after 2009, but with a 35% tax rate instead of the 55% rate scheduled to apply in 2011.  In addition, the exemption amount is $5 million rather than the feared $1 million.  Further, the exemption is “portable” whereby if one spouse dies without using up his or her exemption amount, any unused amount will be tacked onto the surviving spouse’s exemption.  However, these rates and the portability rule are only applicable through 2012.  What happens after that is subject to election-year politics.

For deaths in 2010, executors can elect to apply the zero tax rate that has been in existence for most of the year.  However, the complicated modified carryover basis rule would apply rather than the stepped-up basis rule.  So for estates of $5 million or less that have appreciated assets, the new rule 35% rate with the $5 million exemption will likely be better.

For gifts made after 2010, the 35% gift tax rate that was in existence in 2010 will continue to apply but with an exclusion amount of $5 million rather than the $1 million exclusion applicable in 2010.  The annual $13,000 per person exclusion continues to apply also.

The generation-skipping transfer (GST) tax rate and exemption will be the same as the gift tax amounts after 2010.  For 2010, the zero rate and $1 million exemption still applies.

 

Small Business Stock Exclusion
As discussed in our October briefing (see www.wblcpa.com), a 100% exclusion for gain on sales of certain small business stock was put in place for stock acquired after September 27, 2010 and before January 1, 2011.  This incentive has been extended for stock acquired in 2011.  As a quick reminder, the stock has to be that of a C Corporation that is an active trade or business with assets of $50 million or less when issued.  The stock must be held for more than five years.  The exclusion is limited to the greater of $10 million or ten times the taxpayer’s basis in the stock.

 

Impact on Filing Season? 
The IRS has already announced that it will not be able to accept many 2010 tax returns until mid-to-late February due to the changes in the December Tax Act.  Among others, affected taxpayers include those who file Schedule A to itemize their deductions.  The IRS needs time to change forms and reprogram its computers.  So now some of our favorite procrastinators can blame the politicians and the IRS.

Speaking of filing season, more individuals will now be required to E-file their returns.  The IRS has been encouraging electronic filing for years. In prior years they have required certain partnership and corporate tax returns to be filed electronically, but not individual returns. In 2011, individual, trust and nonprofit tax returns prepared by CPA firms are generally required to be filed electronically. If you have been filing paper returns in the past, please be sure we have a good email address for you. The e-filing process is fairly painless and provides confirmation that the return was filed on time.

 

Concluding Thoughts
The Tax Act took the edge off of what was otherwise an anxious year-end planning season for us.  With the same tax rates in place for the next several years, the typical planning strategies of deferring income and accelerating deductible expenses at year-end generally continue to apply.  Unfortunately, the anxiety will return in 2012 and election-year politics will likely rule the day.  As always, we will continue to monitor closely what is going on in Washington and report to you what we see.  But feel free to contact us any time with your specific questions.

In the meantime, all of us at Williams Benator & Libby wish you and your families a happy and healthy new year.