Wipfli Alerts & Updates: 2010 Tax Relief Act—Finally Some Holiday Cheer!
December 17, 2010
The “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (2010 Tax Relief Act) has passed votes in both the Senate and the House of Representatives and will now be sent to the President for his signature this afternoon. Over the next two years, the provisions included in the Act will put significant cash in the hands of taxpayers. However, the ultimate fate of the “Bush tax cuts” is postponed until 2012, when they will undoubtedly play an important role in the Presidential elections.
Included in the legislation are the tax provisions previously agreed to by President Obama and Republicans that extend the Bush tax cuts for two years. The 2010 Tax Relief Act will extend for two years the EGTRRA income tax rates and the JGTRRA tax rates for long-term capital gains and qualified dividends, “patch” the alternative minimum tax (AMT) for two years, provide estate tax relief for two years, create a two percentage point cut in employee-paid payroll taxes and self-employment tax for 2011, give businesses new incentives to invest in machinery and equipment, and retroactively resuscitate and extend a host of tax breaks for individuals and businesses.
Provisions Applicable to Individual Taxpayers
One of the largest benefits included in the Act is the temporary reduction in the payroll tax imposed on employees and self-employed individuals. Under current law, employees pay a 6.2% Social Security tax on all wages earned up to $106,800 (in 2011), and self-employed individuals pay 12.4% Social Security tax on all of their self-employment income up to the same threshold. The 2010 Tax Relief Act provides a payroll/self-employment tax holiday during 2011 of two percentage points. As a result, employees will pay only 4.2% Social Security tax on wages, and self-employment individuals will pay only 10.4% Social Security tax on self-employment income up to the threshold.
The parts of the 2010 Tax Relief Act that are getting the most negative press are those extending the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16)— commonly referred to as the “Bush tax cuts.” Other than those made permanent or extended by subsequent legislation, the Bush tax cuts were scheduled to sunset and no longer apply to tax or limitation years beginning after 2010. However, the 2010 Tax Relief Act postpones the sunset rule for two years, until tax or limitation years beginning after 2012. Thus, all of the following favorable tax rules (among others) will remain in place through 2012:
- The income tax rates for individuals stay at 10%, 15%, 25%, 28%, 33%, and 35% (rather than increasing to 15%, 28%, 31%, 36%, and 39.6%).
- Long-term capital gains will continue to be taxed at a maximum rate of 15% (instead of 20% [18% for assets held more than five years]).
- Qualified dividends paid to individuals will be taxed at the same maximum 15% rate as long-term capital gains (instead of being taxed as ordinary income).
- The size of the 15% tax bracket for joint filers and qualified surviving spouses remains at 200% of the 15% tax bracket for individual filers (rather than dropping to 167%).
- The standard deduction for joint filers and qualified surviving spouses remains at 200% of the standard deduction for individual filers (rather than dropping to 167%). The standard deduction for individuals who are married filing separately is half of the joint filer amount.
- Itemized deductions of higher-income taxpayers are not reduced. (After 2010 they would have been reduced by 3% of AGI above an inflation-adjusted figure, but the reduction could not exceed 80%.)
- A higher-income taxpayer's personal exemptions are not phased out when AGI exceeds an inflation-adjusted threshold. (Personal exemptions would have phased out after 2010.)
The current rules for the following tax provisions also will remain in place through 2012:
- Coverdell Education Saving Accounts (CESAs), formerly called education IRAs;
- The exclusion for employer-provided educational assistance;
- The exemption from the payments-for-services rule for amounts received under certain government health professions scholarship programs;
- The above-the-line student loan interest deduction;
- The credit for employer-provided child care facilities;
- The earned income tax credit (EITC);
- The credit for household and dependent care; and
- The child tax credit.
The Act also defers for two years the sunset rule of Sec. 303 of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA, PL 108-27). As a result, the AMT “patch” is renewed for two additional years.
Under the 2010 Tax Relief Act, the AMT exemption amounts for 2010 and 2011 will be as follows:
|Married Filing Jointly/Surviving Spouse|
|Married Filing Separately|
For both years, the AMT exemption is phased out at the rate of 25% of the amount that alternative minimum taxable income (AMTI) exceeds $150,000 for married individuals filing jointly, $112,500 for single individuals, and $75,000 married individuals filing separately.
According to the Tax Policy Center, without this change, the percentage of taxpayers subject to AMT would increase from 5.2% to 33.9%.
Expired Individual Tax Breaks Retroactively Reinstated and Extended Through 2011
Most of the tax breaks for individuals, which expired at the end of 2009, will be retroactively reinstated and extended through 2011, including:
- The $250 above-the-line deduction for certain expenses of elementary and secondary school teachers;
- The election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction permitted for state and local income taxes;
- The increased contribution limits and carryforward period for contributions of appreciated real property (including partial interests in real property) for conservation purposes;
- The above-the-line deduction for qualified tuition and related expenses;
- The provision that permits taxpayers age 70 1/2 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 (In addition, individuals will be allowed to make charitable transfers during January 2011 and treat them as if made during 2010.);
- The increase in the monthly exclusion for employer-provided transit and van-pool benefits to that of the exclusion for employer-provided parking benefits; and
- Extending for an additional year (i.e., through 2011), the rule allowing premiums for mortgage insurance to be deductible as interest that is qualified residence interest.
Provisions Applicable to Transfer Taxes
EGTRRA phased out the estate and generation-skipping transfer (GST) taxes so that they were fully repealed in 2010, lowered the gift tax rate to 35%, and increased the gift tax exemption to $1 million for gifts made after 2001. The 2010 Tax Relief Act sets the exemption at $5 million per person and $10 million per couple and provides for a top tax rate of 35% for estate, gift, and GST taxes through 2012. The exemption amount will be indexed for inflation beginning in 2012.
The changes will be effective January 1, 2010, but executors will be allowed to make an election to choose no estate tax and modified carryover basis for estates arising on or after January 1, 2010, and before January 1, 2011. In addition, a $5 million GST tax exemption and zero-percent rate will apply for the 2010 year.
Effective for estates of decedents dying after December 31, 2010, the 2010 Tax Relief Act will allow the executor of a deceased spouse's estate to transfer any unused exemption to the surviving spouse (which is often referred to as “portability” of the exemption).
For gifts made after December 31, 2010, estate and gift taxes will be reunified. This means that the lifetime limit on tax-free gifts will increase from $1 million to $5 million.
Provisions Applicable to Businesses
The Act includes the following major new incentives for businesses to invest in machinery and equipment:
- A 100% bonus first-year depreciation allowance under Code Sec. 168(k) for property acquired and placed in service after September 8, 2010, and before January 1, 2012;
- A 50% bonus first-year depreciation allowance under Code Sec. 168(k) for property placed in service after December 31, 2011, and before January 1, 2013;
- Extension through December 31, 2012, of the election to accelerate the AMT credit instead of claiming additional first-year depreciation; and
- For tax years beginning after December 31, 2011, setting the maximum expensing amount under Code Sec. 179 at $125,000 and the investment-based phaseout amount at $500,000. (Under current law, the expensing figures drop from $500,000/$2 million for 2010 and 2011 to $25,000/$200,000 after 2011.)
Expired Business Tax Breaks Retroactively Reinstated and Extended Through 2011
A number of business tax breaks that expired at the end of 2009 will be retroactively reinstated and extended through 2011, including:
- The research credit;
- The new markets tax credit (but with a lower allocation amount than in previous years);
- The employer wage credit for activated reservists;
- The 15-year write-off for qualifying leasehold improvements, restaurant buildings and improvements, and retail improvements;
- The 7-year write-off for motor-sports entertainment facilities;
- The enhanced charitable deductions for contributions of food inventory, contributions of book inventories to public schools, and corporate contributions of computer equipment for educational purposes;
- The expensing of environmental remediation costs;
- The allowance of the Code Sec. 199 domestic production activities deduction for activities in Puerto Rico; and
- The work opportunity tax credit (but with modifications—see below).
Miscellaneous Provisions Extended Through 2011
The list of energy-related provisions that will be extended through 2011 includes:
- The $1.00-per-gallon production tax credit for biodiesel, as well as the small agri-biodiesel producer credit of $.10 per gallon;
- The $1.00-per-gallon production tax credit for diesel fuel created from biomass;
- The placed-in-service deadline for qualifying refined coal facilities;
- The credit for manufacturers of energy-efficient residential homes;
- The $0.50-per-gallon alternative fuel tax credit (but the credit will not be extended for any liquid fuel derived from a pulp or paper manufacturing process);
- The suspension on the taxable income limit for purposes of depleting a marginal oil or gas well;
- The Code Sec. 45M credit for U.S.-based manufacture of energy-efficient clothes washers, dishwashers, and refrigerators (with modified standards—see below);
- The Code Sec. 25C credit for energy-efficient improvements to existing homes, reinstating the credit as it existed before passage of the American Recovery and Reinvestment Act (Standards for property eligible under Code Sec. 25C are updated to reflect improvements in energy efficiency.); and
- The 30% investment tax credit for alternative vehicle refueling property.
Disaster Relief Provisions Extended
Various disaster relief provisions also will be extended through 2011, including:
- The time for issuing New York Liberty Zone bonds, effective for bonds issued after December 31, 2009;
- The increased rehabilitation credit for qualified expenditures in the Gulf Opportunity Zone; and
- The additional depreciation deduction claimed by businesses equal to 50% of the cost of new property investments made in the Gulf Opportunity Zone. (Expenditures in 2011 will be eligible if the property is placed in service by December 31, 2011.)
Significant Extenders Not Renewed and Others Cut Back
Since EGTRRA was passed in 2001, Congress has systematically extended approximately 50 popular but temporary tax provisions as they have expired (or were set to expire). Generally, all of the provisions were lumped into a large “extenders” package and renewed without debate on the individual merits of specific provisions. However, the current Act changes this pattern by excluding several major provisions that will now be allowed to expire.
One of biggest nonrenewals in terms of dollar value is Obama's Making Work Pay credit, which was enacted in the American Recovery and Reinvestment Act of 2009 (P.L. 111-5), and which the payroll tax cut is designed to replace. Other incentives that will expire for individuals include the exclusion from income of benefits for volunteer firefighters and emergency medical responders and the additional standard deduction for state and local property taxes.
Several infrastructure-related incentives—including Build America Bonds, exempt-facility bonds for sewage and water supply facilities, and recovery zone bonds—were left out of the legislation, as was a provision granting tax-exempt eligibility to loans guaranteed by federal home loan banks.
Provisions making it more attractive for banks to invest in tax-exempt bonds from small issuers will also expire.
Some low-income housing benefits will disappear, such as a temporary increase in the volume cap for the low-income housing credit and an election to substitute grants for the credits.
The Code Sec. 30B(k) credit for alternative motor vehicles will be allowed to expire, as will the credit for electricity produced at open-loop biomass facilities and the incentives targeting steel industry fuel. The Code Sec. 45M credit for energy-efficient appliances will be extended but will be made more stringent, so that new dishwashers and other devices will be required to save more energy than older models to earn the same level of credit.
The Work Opportunity Tax Credit will be renewed, but unemployed veterans and "disconnected youth" will lose the targeted group status they held under the credit in 2009 and 2010.
A handful of tax cuts for timber gains will also be allowed to expire.
Although Senate Finance Committee Chair Max Baucus, D-Montana, had proposed renewing several of the extenders left out of the Act, that bill fell to Republican objections on the Senate floor.
A Few Important Planning Thoughts
The 2010 Tax Relief Act does bring some holiday cheer in the form of lower taxes, as well as provides some certainty before year-end. In light of the provisions included in the Act, both those we expected and a couple of surprises, it is important to keep the following planning points in mind:
- Because lower tax rates are preserved for two additional years, there generally is no benefit to accelerating income to 2010 or deferring deductions to 2011.
- Individuals making Roth conversions in 2010 should more closely consider the election to include 50 percent of the income triggered on the conversion in 2011 and 2012. In addition to tax rate impacts, individuals should consider AMT exposure and any expiring tax attributes (e.g., NOLs, charitable carryovers, capital loss carryovers, expiring tax credits, etc.), among other things.
- Businesses should accelerate plant and equipment purchases to the final days of 2010 to take advantage of 100% bonus depreciation this year.
- Businesses should accelerate plant and equipment purchases to 2011 to take advantage of 100% bonus depreciation in 2011.
- Businesses should accelerate expensing of qualified property under Code Sec. 179 to the final days of 2010 and 2011, when the higher deduction limitations apply.
- Individuals who already have used their $1 million applicable gift tax exclusion or who are considering making large taxable gifts in 2010 should consider deferring the gifts until 2011 to take advantage of the significant increase in the applicable gift tax exclusion (to $5 million).
- Individuals who already have made taxable gifts during 2010 should consider whether the gift can be undone, either by rescission or qualified disclaimer, and then wait to make the gift in 2011. Remember to also consider possible variations in the value of the gifted property.
- Individuals who expect to make more than $5 million of GST at death should considering accelerating them to 2010 to avoid exhausting their valuable GST exemption.
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