What a (Tax) Relief: Congress Temporarily Averts Huge Tax Increases

After waiting until almost the last minute, Congress averted tax increases that would have affected taxpayers at all income levels and added some 15 million lower-income workers to the tax rolls.1

Had Congress not passed the 2010 Tax Relief Act (H.R. 4853), tax rates for income, capital gains, dividends, and estates would have reverted to higher pre-2001 levels in 2011. Rates for these taxes were reduced in 2001 and 2003 but were subject to a December 31, 2010, expiration date because of the political climate at the time. The new law pushes their expiration dates to December 31, 2012.

Despite the uncertainty created by yet another temporary tax law, there are many encouraging provisions that result in some of the most favorable tax conditions Americans have seen in a generation.

What’s New and What’s Not?

One-year payroll tax cut. Employees may notice slightly more take-home pay in 2011 because the employee’s share of the Social Security payroll tax has been temporarily reduced from 6.2% to 4.2% of income (on up to $106,800 in taxable wages). The employer’s share (6.2% of an employee’s pay) did not change. For the self-employed, the Social Security payroll tax has been reduced from 12.4% to 10.4%.

Estate tax revival. Although the federal estate tax is back after being repealed in 2010 (for one year only), the new parameters are more generous than those that had been scheduled for 2011 (a $1 million exemption and a 55% top tax rate).

For individuals who leave behind an estate before December 31, 2012, assets in excess of a $5 million applicable exemption will be subject to a top rate of 35%. Married couples who take the appropriate steps may be able to pass up to $10 million tax-free to their heirs.

The new law also brings back the stepped-up basis rules, which allow heirs to calculate their basis in an asset according to its value on the date of inheritance. Heirs who inherited assets in 2010 can elect to use the modified carryover basis rules that were in place for that year (meaning they must calculate capital gains using the decedent’s basis) or they can apply the new $5 million exemption and 35% top rate and use the stepped-up basis rules.

Gift tax reunified with the estate tax. Gifts in excess of the donor’s $5 million lifetime exemption are subject to a maximum 35% rate.

Itemized deductions for high incomes. The repeal of the so-called Pease limitation, which reduces the use of certain deductions for taxpayers with incomes in excess of certain levels, has been extended through 2012.

No phaseout of the personal exemption. High-income taxpayers will be allowed to claim the full personal exemption through 2012. Prior to 2010, the exemption was phased out for taxpayers with incomes in excess of certain thresholds.

Two more years of AMT relief. Middle-income taxpayers may be able to avoid the alternative minimum tax for at least two more years. The AMT was crafted in 1970 to keep wealthy taxpayers from using exemptions and deductions to avoid income taxes, but it has started to affect less affluent taxpayers because the limits aren’t indexed to inflation. The new exemption amounts for 2010 and 2011 are $47,450 and $48,450, respectively, for single filers ($72,450 and $74,450, respectively, for married taxpayers filing jointly).

Capital gains and dividends. Long-term capital gains and qualifying dividends will continue to be taxed at a 0% rate for individuals in the 10% and 15% income tax brackets and at a maximum 15% rate for other taxpayers. After 2012, long-term capital gains will be taxed at a maximum 20% rate and dividends will be taxed as ordinary income.

Income taxes. The 2010 Tax Relief Act includes a two-year extension of the income tax rates that have been in effect since 2003.

These are just the highlights. Several other provisions have been extended. Before you take any action, consult your Naperville tax preparation advisor for information about your situation.

1) The Wall Street Journal, December 17, 2010

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2011 Emerald Connect, Inc.

Wednesday, February 2, 2011