On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“Tax Relief Act”). Pursuant to the Tax Relief Act, certain tax cuts that were enacted during the Bush Administration have been extended until December 31, 2012.
The Tax Relief Act extended through 2012 the individual income tax rate schedule, which provides for a maximum tax rate on ordinary income of 35%. Without passage of the Tax Relief Act, the individual income tax rate schedule that was introduced during the Clinton Administration, with a maximum tax rate of 39.6%, would have taken effect in 2011. The income tax rate schedule for estates and nongrantor trusts, with a maximum tax rate of 35% on ordinary income, was also extended through 2012 by the Tax Relief Act.
Under the Tax Relief Act, the lower tax rate on long-term capital gains and qualifying dividends has been extended until December 31, 2012. Except for certain items such as unrecaptured Section 1250 gain on real property (25%) and collectibles (28%), the maximum tax rate on long-term capital gains and qualifying dividends is 15%. Without the Tax Relief Act, for 2011, the maximum tax rate on long-term capital gains would have increased to 20% and dividends would be taxed as ordinary income.
Besides the extension of Bush-era tax cuts referenced above, the Tax Relief Act contains other beneficial provisions. For example, an Alternative Minimum Tax (AMT) patch was added for 2010 and 2011. The term, “AMT patch,” refers to the AMT exemption level that prevents many taxpayers from being subject to the AMT. Examples of temporary individual income tax incentives that were extended under the Tax Relief Act include the following:
- Charitable contribution on IRA proceeds
- Charitable contributions of appreciated property for conservation purposes
- The higher education tuition deduction
- The teacher’s classroom expense deduction
- The alternative state and local sales tax deduction (used when greater than the state income tax deduction)
Without the Tax Relief Act, the foregoing list of temporary individual income tax incentives would have expired on December 31, 2009.
For 2011, the Tax Relief Act reduced the employee portion of Social Security taxes on wages up to $106,800 from 6.2% down to 4.2%. For self-employed individuals, the 2011 self-employment tax rate is 10.4% up to the $106,800 threshold. Instead of a deduction for one-half of the self-employment tax in computing adjusted gross income in 2011, the income tax deduction will be slightly greater than one-half of the self-employment tax thereby bringing this income tax deduction into parity with the FICA taxes paid and deducted by employers who are subject to this payroll tax.
Prior to the Tax Relief Act, certain small business stock could be purchased by non-corporate taxpayers on or before December 31, 2010 and, after a five year holding period, be sold with a 100% exclusion from tax on the gain, subject to certain dollar limitations. The Tax Relief Act added a one year extension for acquiring small business stock that qualifies for the 100% exclusion (i.e., a stock purchase made on or before December 31, 2011).
The research tax credit was scheduled to expire on December 31, 2009; however, the Tax Relief Act renewed and extended this credit until December 31, 2011. Without going into the specific details, there were several other targeted business income tax incentives that expired on December 31, 2009. The Tax Relief Act generally extended such business tax incentives until December 31, 2011.
The Tax Relief Act revived the estate tax for decedents dying after December 31, 2009. With respect to individuals who died in 2010, an interesting choice is presented. The executor or administrator can choose to apply the estate tax and obtain a raised basis to fair market value for qualifying assets that are included in the estate. The other choice is to not apply the estate tax and be required to use the modified carryover basis rules on certain assets included in the estate. An estate tax payment will not be due if the taxable estate does not exceed $5 million. The maximum estate tax rate is 35%. The new estate tax rules are temporary and are scheduled to expire on December 31, 2012.
As with any significant transaction or tax planning strategy, it is wise to seek counsel from a competent tax professional before entering into a transaction.
Posted by David DuWaldt