Tax Law Changes: The 2010 Tax Relief and Job Creation Act

The news has recently been abuzz with the new tax legislation passed by Congress and approved by the President. This newsletter will explain in more detail a substantial portion of the content of the recently passed tax legislation and how the new relief provisions may affect you.

On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act). The Act extends the Bush era tax cuts, temporarily extends unemployment insurance benefits, and includes other temporary business and individual tax incentives. However, the Act does not include any revenue offsets.

The Joint Committee on Taxation staff estimates that the Act will deliver $801 billion of tax and $56 billion of direct spending benefits over 10 years.

Summary of the Act’s Provisions

•Extension of the current individual income tax rates for two years through 2012.

•Extension of a higher alternate minimum tax (AMT) exemption and allowance of nonrefundable personal credits against the AMT for 2010 and 2011

•Temporary estate tax relief with an exemption of $5 million per person and rates up to 35 percent with an election out for 2010.

•Extension of 50 percent bonus depreciation through 2012 and a 100 percent expensing allowance for property placed in service after September 8, 2010, through 2011.

•A one-year reduction in the employee’s share of the social security tax from 6.2 percent to 4.2 percent.

•Extension through 2011 of provisions that expired at the end of 2010 including the research and experimentation credit and the section 1603 credit providing grants for energy property in lieu of production or investment tax credits.

Individuals

Individual Tax Rates

The Act extends all individual rates at 10, 15, 28, 33, and 35 percent for two years, through December 31, 2012. After the sunset of these tax rate extensions, the top individual tax rate will rise to 39.6 percent.

The top individual tax rate in 2013 does not include the rate increases enacted by the Patient Protection and Affordable Care Act of 2010. This increase includes an additional 0.9 percent Medicare Hospital insurance tax on self-employed individuals and employees and an unearned income Medicare contribution of 3.8 percent on certain investment income.

Capital Gains / Dividends

During 2010, qualified capital gains and dividends were taxed at a maximum rate of 15 percent (zero percent for taxpayers in the 10 and 15 percent income tax brackets). The Act continues this treatment for two years, through December 31, 2012. Additionally, the rates on qualified dividends will remain at 15 percent over the next two years. Qualified dividends are dividends received from a domestic corporation or a qualified foreign corporation.

Itemized Deduction Limitation

The Act extends full repeal of the Pease limitation, through December 31, 2012. The Pease limitation reduces the total amount of a higher-income individual’s otherwise allowable deductions.

Marriage Penalty Relief

Previously, some two-earner couples experienced a “marriage penalty” meaning their joint tax liability was greater than the sum of their separate individual tax liabilities (computed as if they were single). The marriage penalty relief is an increase in the basic standard deduction for a married couple filing a joint return to twice the amount for a single individual and an expansion in the 15 percent bracket for joint filers to twice that of single filers. The Act extends this current marriage penalty relief for two years, through December 31, 2012.

Child Tax Credit

The Act extends through 2012 the child tax credit modifications made by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the American Recovery and Reinvestment Act of 2009 (ARRA). Under EGGTRA, the credit was increased from $500 to $1,000, taxpayers were allowed to claim the credit fully against the AMT, and families with fewer than three children were allowed to claim the credit. Under ARRA, the threshold for claiming the refundable credit was reduced to $3,000 of earned income.

Alternative Minimum Tax Relief

The Act provides an AMT “patch” intended to prevent the AMT from encroaching on middle income taxpayers by providing higher exemption amounts and other targeted relief for 2010 and 2011. The Act increases the exemption amounts for 2010 to $47,450 for individual taxpayers, $72,450 for married taxpayers filing jointly and surviving spouses, and $36,225 for married couples filing separately.

Payroll Tax Cut

The Act includes a new temporary reduction of the Social Security payroll tax for wage earners and self-employed individuals. As a result, the 6.2 percent and 12.4 percent rates applicable under current law to wage earners and self-employed individuals are reduced, respectively, to 4.2 and 10.4 percent for 2011. Employees will receive the benefit of the payroll tax holiday through reduced withholdings. Self-employed individuals can reflect the reduced rates in their estimated tax payments.

Planning Considerations

With the retention of the tax cuts, tax planning methods used by taxpayers during past years will largely remain the same. Tax planning will focus on the individual’s specific circumstances rather than issues related to changing income tax rates.

Those with substantial investment income can now make decisions about rebalancing investment portfolios with confidence about the tax impact of earning dividend income or capital appreciation. Because the tax rates are set for the next two years, other tax planning issues such as acceleration of income or deferral of deductions become less relevant in the short term. This may all change when the tax extensions expire in 2 years.

Business Incentives

Bonus Depreciation

The Act boosts 50 percent bonus depreciation to 100 percent for qualified investments made after September 8, 2010, and before January 1, 2012. The Act also makes 50 percent bonus depreciation available for qualified property placed in service after December 31, 2011, and before January 1, 2013. Certain long-lived property and transportation property is eligible for 100 percent expensing if placed in service before January 1, 2013.

The Act provides for another temporary election to claim a refundable credit in lieu of bonus depreciation for property placed in service during 2011 and 2012. This election allows corporations to monetize a portion of their AMT credit (if originally generated in taxable years beginning before 2006) in lieu of claiming bonus depreciation.

State Tax Implications

Taxpayers operating in states that do not follow the federal bonus depreciation rules will face increases in the complexity of state tax returns and provision and will have to maintain detailed recordkeeping so that state and federal differences can be reconciled.

Section 179 Limitation

The Small Business Jobs Act of 2010 increased the section 179 dollar and investment limits to $500,000 and $2 million, respectively, for 2010 and 2011.

The Act provides an additional year of increased section 179 expensing, but at lower levels than those in effect for 2010 and 2011. For tax years beginning in 2012, the limitation is raised to $125,000, and the reduction begins at $500,000. Those amounts will return to $25,000 and $200,000, respectively, after 2012.

Disclaimer Required by IRS Rules of Practice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

This publication is intended for general information purposes. It does not constitute legal advice. The reader should consult with knowledgeable legal counsel to determine how applicable laws apply to specific situations. Articles in this publication are based on the most current information available at the time they were written. Since it is possible that the law and other circumstances may have changed since this publication, please call us to discuss any actions you may be considering as a result of reading an article.