by Terri Judycki, CPA, MST , published on 01/17/2011

in Business West

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Tax Relief Act) was signed into law Dec. 17, 2010, avoiding what would have been one of the largest tax increases in history if Congress and the president had not compromised.

As background, in 2001 and 2003 Senate Republicans were not certain they could pass permanent tax cuts with the required votes. As a result, both the 2001 and 2003 tax cut acts were passed as reconciliation bills that needed fewer votes. Under the ‘Byrd rule,’ bills passed under reconciliation may not alter federal revenue for more than 10 years. Consequently, the 2001 and 2003 tax cuts were scheduled to sunset after 2010.

The 2010 Tax Relief Act extends the Bush-era individual income tax cuts for all taxpayers and makes many other changes. A brief description of some of the provisions follows.

Individual Income Tax Rates

The sunsetting of the tax cuts would have resulted in tax rates of 15%, 28%, 31%, 36%, and 39.6%. Under the 2010 Tax Relief Act, individual income-tax rates will remain at the current levels for 2010 and 2011: 10%, 15%, 25%, 28%, 33%, and 35%.

Capital Gains/Qualified Dividends

The maximum rate of 15% for long-term capital gains and qualified dividends have also been extended through 2012. Taxpayers in the 10% and 15% tax brackets continue to pay 0% on this income. Had this provision been permitted to expire, the maximum rate of tax would have been 20% on long-term capital gains, 39.6% on qualified dividends.

Itemized Deduction and

Personal Exemption Limitations

Higher-income individuals would again have found their itemized deductions and personal exemptions reduced. Under the 2010 Tax Relief Act, higher-income taxpayers will receive benefit of the full deduction through 2012.

Marriage Penalty Relief

This refers only to the tax penalty. The expiring tax provisions provided that the standard deduction and the 15% tax bracket for married couples filing jointly were double that of a single filer. This is extended through 2012.

Alternative Minimum Tax (AMT)

The 2010 Tax Relief Act includes an AMT patch for 2010 and 2011. The patch provides increased exemption amounts to avoid impacting many middle-class taxpayers.

Charitable Incentives

The Tax Relief Act extends several charitable incentives, including tax-free distributions from IRAs to charitable organizations.

Individual Tax Credits

The act extends various credits through 2012, including the $1,000 child tax credit and the American Opportunity Tax Credit for higher education expenses.

Individual Tax Extenders

Expiring at the end of 2009, the following were extended for 2010 and 2011: state and local sales-tax deduction, higher-education tuition deduction, and teacher’s classroom-expense deduction.

Payroll Tax Cut

For 2011 only, the employee portion of the Social Security tax is reduced from 6.2% to 4.2%. The self-employment tax rate is also reduced by 2%. In 2009 and 2010, the Making Work Pay credit provided a $400 credit to single filers and $800 to taxpayers filing jointly, subject to phaseout for higher-income taxpayers. This new payroll tax ‘holiday’ has no income limitation. Therefore, jointly filing taxpayers who make more than $40,000 will receive more under the new holiday, while those public employees who do not pay into Social Security will not receive any benefit.

Section 179 Expensing

Under Section 179, a business meeting certain limits can currently expense the cost of asset purchases. The 2010 Small Business Jobs Act increased the expense limit to $500,000 for businesses with maximum investment for the year of $2 million for 2010 and 2011. The 2010 Tax Relief Act provides for a 2012 limit of $125,000 for businesses with a maximum investment of $500,000, indexed for inflation. Setting the 2012 limit now may permit businesses to budget capital improvements.

Bonus Depreciation

Under the 2010 Small Business Jobs Act, businesses could claim 50% bonus depreciation on qualified assets. Under the Tax Relief Act, bonus depreciation is increased to 100% for qualifying assets placed in service between Sept. 9, 2010 and Dec. 31, 2011. For assets placed in service during 2012, 50% bonus depreciation will apply. While 100% bonus depreciation sounds like Section 179 expensing, bonus depreciation is not subject to limitations for businesses that make large capital-asset purchases and is not subject to the Section 179 income limitations. Unlike Section 179 expensing, bonus depreciation can create or increase a net operating loss. On the other hand, many states do not allow bonus depreciation, but do allow Section 179 if claimed on the federal return.

Tax Credits

Several credits were extended, including the research credit that had expired at the end of 2009, as well as various energy credits.

Estate and GST Taxes

The 2001 tax cut phased out the estate and generation-skipping transfer (GST) taxes so that they were fully repealed in 2010. In 2009, there was a $3.5 million estate/GST tax exemption and a 45% estate-tax rate. In 2010, in lieu of estate taxes, a modified carryover basis would apply to assets owned by a decedent. In 2011, the estate/GST tax was scheduled to return with a $1 million exemption and estate tax rates up to 60%.

The 2010 Tax Relief Act reinstates the estate tax for decedents dying after Dec. 31, 2009, but with a $5 million exemption and a 35% estate tax rate. Estates of decedents dying in 2010 have the option to elect either the new estate tax or the modified carryover basis. There are also significant opportunities for GST tax planning, but those changes are too technical for this article. Suffice it to say that many wealthy taxpayers should be funding new GST trusts by the end of 2010. The new estate-tax regime is once again temporary and scheduled to sunset at the end of 2012.

Conclusion

The 2010 Tax Relief Act also included temporary extension of unemployment insurance, with the total cost estimated at about $858 billion by the Joint Committee on Taxation.

The new law allows taxpayers to plan through 2012, a presidential election year. One of the bigger battles this year concerned extending the tax cuts for higher-income taxpayers, not just those making less than $200,000 if single ($250,000 if filing jointly) as proposed by the Obama administration. It’s reasonable to expect that debate to resurface in 2012.

Terri Judycki, CPA, MST, is senior tax manager with the certified public accounting firm Meyers Brothers Kalicka, P.C., based in Holyoke; (413) 536-8510.