Overview of 2010 Tax Relief Act

Transcription

1 TAXES IN YOUR PRACTICE Overview of 2010 Tax Relief Act by SCOTT E. VINCENT The recently enacted Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Act ) is a sweeping tax package with multiple and varied provisions, including a two-year extension of the Bush tax cuts, estate tax relief, a two-year patch of the alternative minimum tax (AMT), a twopercentage-point cut in employee-paid payroll taxes and in self-employment tax for 2011, new incentives to invest in machinery and equipment, and a host of retroactively resuscitated and extended tax breaks for individuals and businesses. Outlined here are several key elements of the package for your consideration. Extension of Bush Tax Cuts The heart of the recently enacted 2010 Act is a two-year extension of the Bush tax cuts. The Bush Tax Cuts (for historical reference) The Bush tax cuts refer primarily to tax changes in two major pieces of legislation back in 2001 and 2003: the Economic Growth and Tax Relief Scott E. vincent Vincent, Fontg & Hansen, LLC Kansas City 56 / Journal of the Missouri Bar Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) The 2001 legislation (EGTRRA) was a 10-year, $1.35 billion tax cut package that was the largest tax cut since Key elements of EGTRRA included: A lowering of individual income tax rates from 15 percent, 28 percent, 31 percent, 36 percent, and 39.6 percent to 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent. A doubling of the child tax credit from $500 to $1,000. A gradual reduction in estate taxes, culminating in a one-year repeal in 2010 (but reinstatement in 2011). A key element of the 2001 tax cuts, at least for current purposes, is that they were temporary, set to expire at the end of 2010 unless Congress acted to extend them. The 2003 legislation (JGTRRA) accelerated certain tax changes passed in EGTRRA, but the centerpiece of the law was a cut in the top capital gains rate from 20 percent to 15 percent and a cut in the top individual rate on dividends from 35 percent to 15 percent. Under the 2003 legislation, the capital gains and dividends cuts were set to expire after 2008, but they were later extended through the end of New law extends lower rates for all taxpayers for two years The new law extends lower rates for all taxpayers. Under the new law, the rates that have been in effect in recent years 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent will remain in place. However, the extension is only for two years, through New law extends lower capital gains rates for two years For individuals, capital gains are generally taxed at a preferential rate in comparison to ordinary income. The lower rate of tax depends on both the investor s tax bracket and how long the investment was held before being sold. Short-term capital gains on investments held for a year or less are taxed at the investor s ordinary income tax rate. Long-term capital gains, which apply to assets held for more than one year, are taxed at a lower rate than short-term gains. Since 2008, the tax rate on longterm capital gains has been 0 percent for individuals in the 10 percent and 15 percent income tax brackets, and 15 percent for everyone else. However, those rates were scheduled to expire at the end of 2010, as explained above, with the result that in 2011 the longterm capital gains tax rate would have risen to 20 percent (10 percent for taxpayers in the 15 percent tax bracket) if Congress had not acted. The new legislation delays these increases by extending the 0 percent and 15 percent long-term capital gains tax rates for two years, through New law extends lower rates for qualified dividends for two years Since 2003, qualified dividends have been taxed at the same low tax rates that apply to long-term capital gains. For dividend income falling in the higher tax brackets, the rate is 15

2 percent. In the first two brackets (where ordinary income is taxed at 10 percent and 15 percent rates), the dividend rate is 0 percent. To count as qualified, dividendpaying common stocks must be held for at least 61 continuous days before the ex-dividend date the last purchase day for collecting the dividend. For preferred stock, the required holding period is 91 days before the ex-dividend date. The low rates for qualified dividends, like the other Bush tax cuts, were scheduled to expire at the end of If Congress had not acted, beginning in 2011 taxes on dividends would have returned to the rates that were in effect before 2001, and all dividend income received in 2011 would have been taxed as ordinary income. The new legislation prevents dividends from being taxed as ordinary income by continuing the tax regime in effect for qualified dividends (i.e., treatment as long-term capital gains, subject to a 0 percent tax rate for individuals in the 10 percent and 15 percent tax brackets and a 15 percent tax rate for other taxpayers) for two years, through Temporary Payroll Tax Cut One of the biggest tax breaks for individuals in the 2010 Act is the oneyear payroll tax reduction. Under this new provision, the payroll tax (which funds Social Security) will be cut by two percentage points during Here are the details: The Social Security payroll tax on individual wages will be lowered to 4.2 percent in 2011, from the usual 6.2 percent rate. For an individual with wages of $60,000, that amounts to a $1,200 savings for individuals with an income of $60,000. If the individual gets paid twice a month, it will mean an extra $50 in his or her paycheck starting in January. Self-employed workers will also get the tax break. Their self-employment taxes will be cut from 12.4 percent to 10.4 percent. There is no phaseout of the payroll tax reduction for higher income workers. It goes to everyone who works, regardless of income. However, since Social Security taxes apply only to the first $106,800 in earnings in 2011, the benefit for high earners tops out at $2,136. The employer s share of Social Security tax stays at 6.2 percent. Thus, the cost of hiring new workers is not directly affected by the payroll tax reduction. The payroll tax reduction will not affect the worker s future Social Security benefit, because benefits are based on lifetime earnings, not the amount of tax paid by the worker into the Social Security system. AMT Relief The 2010 Act includes a two-year AMT patch for 2010 and 2011 that provides a modest increase in AMT exemption amounts and allows personal nonrefundable credits to offset AMT as well as regular tax. Without the patch, an estimated 21 million additional taxpayers would have owed AMT for Background In recent years, Congress has provided a measure of relief from the AMT by raising the AMT exemption amounts allowances that reduce the amount of alternative minimum taxable income (AMTI), reducing or eliminating AMT liability. However, for 2010, the exemption amounts were scheduled to fall back to the amounts that applied in This would have brought millions of additional middle-income Americans under the AMT system, resulting in higher federal tax bills for many of them, along with higher compliance costs associated with filling out and filing the complicated AMT tax form. New law two-year stopgap fix To prevent the unintended result of having millions of middle-income taxpayers subject to the AMT, Congress has once again relied on a temporary patch to the problem, this time a two-year extension of the 2009 exemption amounts, increased slightly. Under the new law, for tax years beginning in 2010, the AMT exemption amounts are increased to: (1) $72,450 in the case of married individuals filing a joint return and surviving spouses; (2) $47,450 in the case of unmarried individuals other than surviving spouses; and (3) $36,225 in the case of married individuals filing a separate return. For tax years beginning in 2011, the AMT exemption amounts are increased to: (1) $74,450 in the case of married individuals filing a joint return and surviving spouses; (2) $48,450 in the case of unmarried individuals other than surviving spouses; and (3) $37,225 in the case of married individuals filing a separate return. Personal credits may be used to offset AMT through 2011 Another provision in the new law provides AMT relief for taxpayers claiming personal tax credits. The tax liability limitation rules generally provide that certain non-refundable personal credits (including the dependent care credit and the elderly and disabled credit) are allowed only to the extent that a taxpayer has regular income tax liability in excess of the tentative minimum tax, which has the effect of disallowing these credits against the AMT. Temporary provisions had been enacted which permitted these credits to offset the entire regular and AMT liability through the end of The new law extends these temporary provisions to 2010 and January-February 2011 / 57

3 Child and Earned Income Tax Credits Key tax credits for working families that were enacted or expanded in the American Recovery and Reinvestment Act of 2009 are retained under the 2010 Act. There are several important changes to the child tax credit, which is a dollar for dollar tax credit of up to $1,000 for each qualifying child under the age of 17 that taxpayers with incomes below certain levels can take against their federal tax liability. $1,000 maximum child tax credit is extended for two years Previously, the maximum amount of the credit per child was $1,000 through 2010, but was scheduled to drop to $500 after The 2010 Act extends the $1,000 child tax credit through Phaseout amounts are left unchanged The aggregate amount of child credits that may be claimed is phased out (i.e., gradually reduced) for individuals with income over certain threshold amounts. Specifically, the otherwise allowable aggregate child tax credit amount is reduced by $50 for each $1,000 (or fraction thereof) of modified adjusted gross income over $75,000 for single individuals or heads of households, $110,000 for married individuals filing joint returns, and $55,000 for married individuals filing separate returns. The new law leaves these phaseout levels in place. Allowance of the credit against the alternative minimum tax (AMT) is extended for two years The credit is allowable against the regular tax and was previously also allowable against the AMT, although this provision was scheduled to expire after The 2010 Act provides a two-year extension, through 2012, of the allowance of the child tax credit against the AMT. 58 / Journal of the Missouri Bar Expanded rules for the additional child tax credit are extended for two years To the extent the child tax credit exceeds the taxpayer s tax liability, the taxpayer is eligible for a refundable credit (the additional child tax credit) equal to 15 percent of earned income in excess of a threshold dollar amount (the earned income formula). For 2009 and 2010, the threshold was set at $3,000, but under pre-2010 Act law the ability to determine the refundable child credit based on earned income in excess of the threshold dollar amount was set to expire after The new law extends the earned income formula for determining the refundable child credit for two years, through 2012, with the earned income threshold of $3,000. Treatment of refundable portion of child tax credit not as income is extended for two years The new law extends for two years, through 2012, the rule that the refundable portion of the child tax credit does not constitute income and will not be treated as resources for purposes of determining eligibility or the amount or nature of benefits or assistance under any federal program or any state or local program financed with federal funds. Expensing and Accelerated Depreciation The recently enacted 2010 Tax Relief Act includes a wide-ranging assortment of tax changes affecting both individuals and business. On the business side, two of the most significant changes provide incentives for businesses to invest in machinery and equipment by allowing for faster cost recovery of business property. Expansion and extension of additional first-year depreciation Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008, 2009, or 2010 (2011 for certain property), by permitting the first-year write-off of 50 percent of the cost. The new law extends and temporarily increases this additional first-year depreciation provision for investment in new business equipment. For investments placed in service after September 8, 2010 and through December 31, 2011 (through December 31, 2012 for certain longer-lived and transportation property), the new law provides for 100 percent additional first-year depreciation. In other words, the entire cost of qualifying property placed in service during that time frame can be written off, without limit. Note that even though the legislation did not take shape in Congress until mid-december of 2010, the effective date of this provision was made retroactive, to include qualifying property placed in service after September 8, Fifty percent additional first-year depreciation will apply again in The 2010 Act also extends through 2012 the election to accelerate the AMT credit instead of claiming additional first-year depreciation. The new law leaves in place the existing rules as to what kinds of property qualify for additional firstyear depreciation. Generally, the property must be (1) depreciable property with a recovery period of 20 years or less; (2) water utility property; (3) computer software; or (4) qualified leasehold improvements. The original use of the property must commence with the taxpayer used machinery does not qualify. Enhanced small business expensing (Section 179 expensing) Generally, the cost of property

4 placed in service in a trade or business can t be deducted in the year placed in service if the property will be useful beyond the year. Instead, the cost is capitalized and depreciation deductions are allowed for most property (other than land), but are spread out over a period of years. However, to help small businesses quickly recover the cost of capital outlays for qualifying personal property, small business taxpayers can elect to write off these expenditures in the year of acquisition instead of recovering the costs over time through depreciation. The expense election is made available, on a tax year by tax year basis, under 179 of the Internal Revenue Code, and is often referred to as the Section 179 election or the Code Section 179 election. The new law makes three important changes to the Code Section 179 expense election. The new law provides that for tax years beginning in 2012, a small business taxpayer will be allowed to write off up to $125,000 (indexed for inflation) of capital expenditures subject to a phaseout (i.e., gradual reduction) once capital expenditures exceed $500,000 (indexed for inflation). The new maximum expensing amount and phaseout level for tax years beginning in 2012 is actually lower than the levels in effect for tax years beginning in 2010 or 2011 (maximum expensing amount of $500,000, and a phaseout level of $2,000,000). For tax years beginning after 2012, the maximum expensing amount will drop to $25,000 and the phaseout level will drop to $200,000. The rule that treats off-the-shelf computer software as qualifying property is extended through The new law extends, through 2012, the provision permitting a taxpayer to amend or irrevocably revoke a Code Section 179 expense election for a tax year without IRS consent. Estate Tax is Back in Place After a one-year hiatus, the 2010 Act reinstates the estate tax for 2011 and 2012, with a top rate of 35 percent. The exemption amount will be $5 million per individual in 2011 and will be indexed to inflation in following years. Estates of people who died in 2010 can choose to follow either 2010 s or 2011 s rules. Background The modern estate tax dates back to 1916, when it was imposed at a rate of 10 percent on the portion of estates above $50,000. Over the following years, the rates and exemption amounts have varied, reaching a high of 77 percent from 1941 to 1976 with a $60,000 exemption amount. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) lowered the maximum estate tax rate and substantially raised the applicable exclusion amount over the years 2002 through The maximum tax rate fell from 60 percent under prior law in 2001 to 45 percent in EGTRRA repealed the estate tax completely for decedents dying in That led to several well-publicized instances in which famous people died in 2010 leaving multibillion-dollar estates that will pass to their heirs without paying federal estate tax. However, all of those provisions were scheduled to sunset on December 31, 2010, meaning that if Congress had not acted, starting January 1, 2011 the estate tax would have sprung back at a level that no one seemed to want, with an exclusion of only $1 million ($2 million for couples) in 2011 (as compared with $3.5 million per person in 2009). The tax rate would also have risen, from a top rate of 45 percent in 2009, to a top rate of 55 percent in New Estate and Gift Tax Rules The new law brings back the estate tax for at least 2011 and 2012, with a top rate of 35 percent. For 2011, the exemption amount will be $5 million per individual (indexed for inflation after 2011). At those levels, the vast majority of estates (all but an estimated 3,500 nationwide in 2011) will not be subject to any federal estate tax, and the tax will raise about $11.4 billion for the government. By way of comparison, the 55 percent tax with a $1 million exemption would have resulted in about 43,540 taxable estates in 2011, and raised about $34.4 billion. Tax historians have also noted that except for the temporary repeal of the estate tax in 2010, the estate tax rate has not been less than 45% since The new law also gives heirs of decedents dying in 2010 the choice to apply either the 2010 or 2011 estate-tax rules. This choice should be carefully considered, because although there is no estate tax in 2010, some inherited assets are subject to higher capital gains tax under the 2010 rules, which can raise the tax burden for heirs. Inherited assets under the 2010 rules have a tax basis equal to the basis of the decedent in the assets ( carryover basis ) rather than their value at death. This can lead to a significant tax burden for heirs who sell assets such as stocks that had been held for many years and have greatly appreciated in value. Under the 2011 rules, by contrast, heirs will be allowed to inherit assets with a stepped-up basis. While most heirs would choose the 2011 regime ($5 January-February 2011 / 59

5 million exemption from both estate and generation-skipping tax and an unlimited step-up in the basis of assets to their current market value), the heirs of very wealthy decedents could find it more advantageous to elect the original 2010 law (limited step-up in the basis of assets and no estate tax). If the executor does not elect to have the original 2010 rules apply, the estate tax return s due date will not be earlier than the date that is nine months after the new law s enactment date (Sept. 19, 2011). For gifts made after December 31, 2010, the gift tax will be reunified with the estate tax. Under the new law, the estate and gift tax exemptions will be reunified starting in 2011, which means that the $5 million estate tax exemption will also be available for gifts. The law in effect prior to 2010 provided a $3.5 million lifetime exemption for estates, but only a $1 million exemption for gifts. The gift tax rate, starting in 2011, will be 35 percent. The exemption from the generation-skipping tax (GST) the additional tax on gifts and bequests to grandchildren when their parents are still alive will also rise to $5 million from the $1 million it would have been without the new law. The GST tax rate for transfers made in 2011 and 2012 will be 35 percent. From a planning standpoint, a key feature of the new law is that it makes it easier to transfer the $5 million exemption to a surviving spouse, so married couples can shield $10 million of their assets from taxes. The estate tax exemption will be portable and a surviving spouse will be able to use the unused portion of a deceased spouse s exemption. Individual and Business Tax Extenders Many traditional tax extenders are reinstated for two years, retroactively to 2010 and through the end of / Journal of the Missouri Bar Among many others, the extended provisions include 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; the $250 above-theline deduction for certain expenses of elementary and secondary school teachers; and the research Several of these provisions are listed here for your reference. Individual Tax Relief The following tax breaks for individuals that expired at the end of 2009 have been retroactively reinstated by the 2010 Act and extended through 2011: The election to take an itemized deduction for state and local general sales taxes instead of the itemized deduction permitted for state and local income taxes. The above-the-line deduction for qualified higher education expenses. The $250 above-the-line tax deduction for teachers and other school professionals for expenses paid or incurred for books, certain supplies, equipment, and supplementary materials used by the educator in the classroom. The increased contribution limits and carryforward period for contributions of appreciated real property (including partial interests in real property) for conservation purposes. The provision that permits taxfree distributions to charity from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer, per tax year. Individuals were also allowed to make charitable transfers during January of 2011 and treat them as if made during The look-thru rule for certain regulated investment company (RIC) stock in determining the gross estate of non-residents. The increase in the monthly exclusion for employer-provided transit and vanpool benefits to equal that of the exclusion for employer-provided parking benefits. In addition, the new law extends for an additional year (i.e., through 2011) the rule allowing premiums for mortgage insurance to be deductible as qualified residence interest. Business Tax Relief On the business side, the following business tax breaks that expired at the end of 2009 have been retroactively reinstated and extended through 2011 by the 2010 Act: The research and development 15-year writeoffs for qualified leasehold improvements and restaurant buildings (and certain improvements to such restaurant buildings). 7-year writeoffs for certain motorsports racetrack property. The employer wage credit for activated military reservists. The active financing exception from the rules for a controlled foreign corporation predominantly engaged in the conduct of a banking, financing, or similar business. Look-through treatment of payments between related controlled foreign corporations. The Indian employment

6 The new markets tax Accelerated depreciation for business property on an Indian reservation. The railroad track maintenance The special expensing rules for certain film and television productions. The mine rescue team training The election to expense advanced mine safety equipment. Expensing of environmental remediation costs. The deduction allowable for domestic production activities in Puerto Rico. The American Samoa economic development The rules exempting from gross basis tax and from withholding tax the interest-related dividends and short-term capital gain dividends received from a RIC by certain foreign persons (extended to apply to tax years of a RIC beginning before 2012). The special rules for interest, rents, royalties and annuities received by a tax-exempt entity from a controlled entity. Empowerment zone tax incentives. Renewal community tax incentives. Tax incentives for investments in the District of Columbia. The work opportunity credit (extended for four months, through the end of 2011). Qualified zone academy bonds. In addition, the new law extends for an additional year (i.e., through 2011) the temporary exclusion of 100 percent of gain on the sale of certain small business stock. Energy Provisions The following energy provisions were extended by the 2010 Act (through 2011): The credit for manufacturers of energy-efficient new homes. Incentives for biodiesel and renewable diesel. Grants for specified energy property in lieu of tax credits. Provisions related to alcohol used as fuel. The energy efficient appliance The credit for energy-efficient improvements to existing homes. The 30 percent investment tax credit for alternative vehicle refueling property. Disaster Relief Provisions The following disaster relief provisions are extended through 2011: New York Liberty Zone taxexempt bond financing. Increased rehabilitation credit for structures in the Gulf Opportunity Zone. Low-income housing credit rules for buildings in Gulf Opportunity Zones. Tax-exempt bond financing for the Gulf Opportunity Zones. Bonus depreciation deduction applicable to specified Gulf Opportunity Zone extension property. The inclusion of a RIC within the definition of a qualified investment entity under the provisions of the Foreign Investment in Real Property Tax Act. The enhanced deduction for contributions of food and book inventories, and computer equipment for educational purposes. The credit for refined coal facilities. Excise tax credits and outlay payments for alternative fuel and alternative fuel mixtures. The special rule to implement FERCs and state electric restructuring policy. Conclusion The 2010 Act provides wide ranging and varied relief across many types of taxes and affects all taxpayers. We will all need to carefully consider the implications and planning opportunities as we move into 2011, and watch for updates, changes and modifications to existing rules as implemented by the IRS this year. A liberal rule for S corporations making charitable donations. Suspension of the limitation on percentage depletion for oil and gas from marginal wells. January-February 2011 / 61