Before we get into the tax provisions of the Tax Relief Act, we should mention that, as this article was written, about 50 million taxpayers faced an IRS-imposed delay in filing their 2010 personal income tax returns. The delay is due to late Congressional action in passing the Tax Relief Act, causing many taxpayers to wait until mid- to late February to file their 1040 personal income tax returns so that the IRS can re-do many of their forms to deal with the new tax laws.
Those who may need to wait to file include taxpayers claiming:
· itemized deductions on Schedule A of their 1040 (mortgage interest deductions, charitable deductions, medical and dental expense deductions, etc.);
· the higher education tuition and fees deduction (this deduction covers up to $4,000 of tuition and fees paid to post-secondary institutions and is claimed on form 8917); and
· the educator expense deduction (for K-12 educators with out-of-pocket classroom expenses of up to $250).
It is worth noting that the IRS has extended the filing deadline for personal income tax returns from Friday, April 15, to Monday, April 18.
Now, for some of the changes:
Income and Capital Gains Tax Rates. The current federal income tax rates will be retained for two years (2011 and 2012), with a top rate of 35% on ordinary income and 15% on qualified dividends and long-term capital gains.
Social Security Tax Break. In 2011, employees and self-employed workers will receive a reduction of two percentage points in Social Security payroll tax, bringing the rate down from 6.2% to 4.2% for employees and from 12.4% to 10.4% for the self-employed on a maximum earned income of $106,800.
The Medicare tax rate remains the same: 1.45% for employees and 2.9% for the self-employed on all earned income. The income-tax deduction for the self-employed will be increased to 59.6% of the Social Security tax, and 50% of the Medicare tax.
Alternative Minimum Tax. A two-year Alternative Minimum Tax (AMT) “patch” for 2010 and 2011 will keep the AMT exemption near current levels and allow personal credits to offset AMT. Without the patch, an estimated 21 million additional taxpayers would have owed AMT for 2010.
Tax Credits. Key tax credits that benefitted working families and that were enacted or expanded in the American Recovery and Reinvestment Act of 2009 were retained by the Tax Relief Act. Specifically, the new law extends, for two years, the $1,000 child tax credit and maintains its expanded refundability. The refundable credit equals 15% of earned income in excess of $3,000.
The Tax Relief Act also extended rules expanding the earned-income credit for larger families and married couples and extended for two years the higher education tax credit (the “American Opportunity” credit) and its partial refundability.
Depreciation. Businesses can write off 100% of their equipment and machinery purchases, effective for property placed in service from September 9, 2010, through December 31, 2011. For property placed in service in 2012, the new law provides for 50% additional first-year depreciation.
Tax Deductions. Many of the “traditional” tax extenders are extended for two years, retroactively to 2010 and through the end of 2011. Among many other provisions, the Tax Relief Act extends (a) the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes; (b) the $250 above-the-line deduction for certain expenses of elementary and secondary school teachers; and (c) the above-the-line deduction for higher education expenses.
The Tax Relief Act also retroactively reinstates, for 2010 and 2011, the exclusion from gross income of up to $100,000 of qualified charitable distributions directly from a regular IRA or Roth IRA, provided the taxpayer is at least 70½ years old. A qualified distribution made in January 2011 can be treated as made in 2010 for purposes of the $100,000 limitation and the required minimum distribution (RMD) for 2010.
A FEW TIPS
Give to Charity. You don’t have to meet a threshold to deduct your charitable donations. As long as you give to an IRS-qualified organization within the tax year, you usually can claim it as an itemized deduction for the full amount that you give.
Adjust Your Withholding Rate. Make sure you are having only the amount you need withheld from your paycheck. If you over-withhold federal taxes, you’ll get a big refund, but you’ve given up your hard-earned dollars for the other 364 days of the year. On the other hand, do not under-withhold, or you’ll end up owing the IRS at filing time.
Evaluate Educational Accounts for Kids. College costs increase every year, but tax-advantaged savings accounts can help. The key is determining which plan best suits your needs. For example, every state offers a 529 plan, and, although plan contributions are not tax-deductible, the earnings are not taxed. In addition, when you take out funds to pay for eligible expenses, the distributions are also tax-free.
Start a Business. Whether you operate your own business as your main source of income or as a sideline venture, tax laws offer several ways to save. As described above, the tax deduction for equipment and other business-related tools and machinery has been increased. Other popular business tax breaks, such as writing off new business startup costs, and many home office expense deductions also still apply.
February 14, 2011
February 11, 2011
New Tax Laws Impact Planning
On December 17, 2010, Congress and the President finally acted to extend the Bush era tax cuts that would have otherwise expired on December 31. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Tax Relief Act”) includes many taxpayer-friendly provisions for both individuals and businesses.
In this article we focus on how the new law impacts estate and gift tax planning. Bear in mind, though, that these changes are good only through 2012. At that point, we’ll either be back to square one, or Congress will again need to act.
$5 Million Estate Tax Exemption and 35% Rate. The new law includes favorable estate tax provisions for individuals who died in 2010, as well as those who die in 2011 and 2012. First, for individuals who die in 2011 or 2012, there is now a $5 million estate tax exemption and a 35% tax rate that applies to amounts over that. For estates of individuals who died in 2010, taxpayers can choose between (a) the new rules contained in the Tax Relief Act or (b) the rules that were otherwise in effect in 2010, which provided for no estate tax but modified the step-up in basis rules.
Portability of Unused Exemption. Significantly, under the new rules, married individuals who don’t use up their estate tax exemption will be able to pass along the unused amount to a surviving spouse. In other words, unused exemptions of individuals who die in 2011 or 2012 (but not 2010) will be “portable.”
The ability to pass along unused estate tax exemptions to a surviving spouse is a very favorable development. It allows both spouses’ exemptions to be utilized without having to set up a credit shelter trust or engage in other tax planning maneuvers – as long as they both die in 2011 or 2012. Unfortunately, the new portability rules sunset after 2012, so it won’t help decedents who die after 2012. Also, the portability rules do not apply to the generation-skipping transfer tax exemption (gifts to grandchildren or to individuals who are more than 37½ years younger than the person making the gift).
Unlimited Basis Step-ups for Inherited Assets. For heirs of decedents who die in 2011 and beyond, the Tax Relief Act reinstates the familiar rule that allows the federal income tax basis of inherited capital-gain assets (such as real estate and stock) to be stepped up to reflect fair market value on the date of death. This favorable rule is also reinstated for decedents who died in 2010, unless the estate elects to instead use the modified carryover basis rules that were otherwise in effect in 2010. With the restoration of the unlimited basis step-up rules, heirs won’t owe any federal capital gains taxes on appreciation that occurs through the date of death.
Estate and Gift Tax Exemptions and Rates Are Equalized. The Tax Relief Act also sets the lifetime federal gift tax exemption for 2011 and 2012 at $5 million, with the 2012 amount indexed for inflation (ditto for the generation-skipping transfer tax exemption). Thus, the gift and estate tax exemptions are again equalized for 2011 and 2012.
This is a huge improvement over the previous $1 million cap on the lifetime gift tax exemption (which continues to apply for 2010). An unmarried person can now give away up to $5 million while alive without paying any gift tax, and a married couple can give away up to $10 million.
However, keep in mind that, to the extent you dip into your gift tax exemption, your estate tax exemption is reduced on a dollar-for-dollar basis. The tax rate on 2011 and 2012 gifts in excess of the $5 million exemption is 35%, the same as the estate tax rate. Again, due to sunset provisions, the gift tax exclusion reverts to $1 million after 2012.
Clarity for Estates of 2010 Decedents and 2010 Generation-Skipping Transfers. The Tax Relief Act clarifies the estate tax treatment of estates of individuals who died in 2010, and the generation-skipping transfer (GST) tax treatment of generation-skipping gifts made in 2010, but it does so in a weird way. The new law reinstates both taxes for 2010 with $5 million exemptions for each. But, executors have the option of electing out of the estate tax for 2010 in accordance with the 2010 repeal.
If executors elect out of estate tax, the aforementioned modified carryover basis rules apply to heirs for income tax basis purposes. So, heirs of large estates can wind up owing capital gains taxes on appreciation that occurs through the decedent’s date of death, but there won’t be any federal estate tax. If the election out is not made for an estate, the $5 million exemption applies for 2010, and the income tax basis of inherited assets equals fair market value as of the date of death.
For 2010, the GST exemption is also $5 million. However, the 2010 GST rate is deemed to be 0%, so there’s no actual GST liability for 2010. Therefore, large generation-skipping gifts could have been made in 2010, and only the gift tax will be owed (2010 gifts in excess of the $1 million gift tax exemption for that year are taxed at a flat 35% rate). Unlike the estate tax exemption, though, the GST tax exemption is not subject to any portability. As a result, gifts to grandchildren or younger generations must continue to be carefully planned.
In this article we focus on how the new law impacts estate and gift tax planning. Bear in mind, though, that these changes are good only through 2012. At that point, we’ll either be back to square one, or Congress will again need to act.
$5 Million Estate Tax Exemption and 35% Rate. The new law includes favorable estate tax provisions for individuals who died in 2010, as well as those who die in 2011 and 2012. First, for individuals who die in 2011 or 2012, there is now a $5 million estate tax exemption and a 35% tax rate that applies to amounts over that. For estates of individuals who died in 2010, taxpayers can choose between (a) the new rules contained in the Tax Relief Act or (b) the rules that were otherwise in effect in 2010, which provided for no estate tax but modified the step-up in basis rules.
Portability of Unused Exemption. Significantly, under the new rules, married individuals who don’t use up their estate tax exemption will be able to pass along the unused amount to a surviving spouse. In other words, unused exemptions of individuals who die in 2011 or 2012 (but not 2010) will be “portable.”
The ability to pass along unused estate tax exemptions to a surviving spouse is a very favorable development. It allows both spouses’ exemptions to be utilized without having to set up a credit shelter trust or engage in other tax planning maneuvers – as long as they both die in 2011 or 2012. Unfortunately, the new portability rules sunset after 2012, so it won’t help decedents who die after 2012. Also, the portability rules do not apply to the generation-skipping transfer tax exemption (gifts to grandchildren or to individuals who are more than 37½ years younger than the person making the gift).
Unlimited Basis Step-ups for Inherited Assets. For heirs of decedents who die in 2011 and beyond, the Tax Relief Act reinstates the familiar rule that allows the federal income tax basis of inherited capital-gain assets (such as real estate and stock) to be stepped up to reflect fair market value on the date of death. This favorable rule is also reinstated for decedents who died in 2010, unless the estate elects to instead use the modified carryover basis rules that were otherwise in effect in 2010. With the restoration of the unlimited basis step-up rules, heirs won’t owe any federal capital gains taxes on appreciation that occurs through the date of death.
Estate and Gift Tax Exemptions and Rates Are Equalized. The Tax Relief Act also sets the lifetime federal gift tax exemption for 2011 and 2012 at $5 million, with the 2012 amount indexed for inflation (ditto for the generation-skipping transfer tax exemption). Thus, the gift and estate tax exemptions are again equalized for 2011 and 2012.
This is a huge improvement over the previous $1 million cap on the lifetime gift tax exemption (which continues to apply for 2010). An unmarried person can now give away up to $5 million while alive without paying any gift tax, and a married couple can give away up to $10 million.
However, keep in mind that, to the extent you dip into your gift tax exemption, your estate tax exemption is reduced on a dollar-for-dollar basis. The tax rate on 2011 and 2012 gifts in excess of the $5 million exemption is 35%, the same as the estate tax rate. Again, due to sunset provisions, the gift tax exclusion reverts to $1 million after 2012.
Clarity for Estates of 2010 Decedents and 2010 Generation-Skipping Transfers. The Tax Relief Act clarifies the estate tax treatment of estates of individuals who died in 2010, and the generation-skipping transfer (GST) tax treatment of generation-skipping gifts made in 2010, but it does so in a weird way. The new law reinstates both taxes for 2010 with $5 million exemptions for each. But, executors have the option of electing out of the estate tax for 2010 in accordance with the 2010 repeal.
If executors elect out of estate tax, the aforementioned modified carryover basis rules apply to heirs for income tax basis purposes. So, heirs of large estates can wind up owing capital gains taxes on appreciation that occurs through the decedent’s date of death, but there won’t be any federal estate tax. If the election out is not made for an estate, the $5 million exemption applies for 2010, and the income tax basis of inherited assets equals fair market value as of the date of death.
For 2010, the GST exemption is also $5 million. However, the 2010 GST rate is deemed to be 0%, so there’s no actual GST liability for 2010. Therefore, large generation-skipping gifts could have been made in 2010, and only the gift tax will be owed (2010 gifts in excess of the $1 million gift tax exemption for that year are taxed at a flat 35% rate). Unlike the estate tax exemption, though, the GST tax exemption is not subject to any portability. As a result, gifts to grandchildren or younger generations must continue to be carefully planned.
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