Last month, in a rare moment of bipartisan compromise and with (by Congressional standards) blazing speed, Congress and President Obama came together and passed a sweeping tax package, more formally known as the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. President Obama signed the Act into law on December 17, 2010. The following is a brief summary of the key provisions of the Act:
Current income tax rates will be retained for two years (2011 and 2012), with a top rate of 35%.
Capital gains and qualified dividends will continue to be taxed at a top rate of 15% through 2012.
Social security payroll taxes for employees and self-employed workers (which include partners whose incomes are subject to payroll taxes) will receive a reduction in Social Security payroll taxes in 2011, with the “employee-side” rate being reduced from 6.2% to 4.2%.
An AMT “patch” for 2010 and 2011 will keep the the alternative minimum tax exemption near current levels.
Itemized deductions of higher-income taxpayers will not be reduced. Without this provision, itemized deductions would have been reduced by 3% of adjusted gross income above an inflation-adjusted figure, but the reduction couldn’t exceed 80%.
Tax-free distributions from IRAs to charities are retained for 2011 only. This provision allows taxpayers age 70 1/2 or older to make distributions of up to $100,000 from their Individual Retirement Accounts (IRAs) to charities. In addition, individuals will be allowed to treat IRA transfers to charities during January of 2011 and as if made during 2010).
Businesses expensing equal to 100% will be permitted on the cost of a business’ purchase of equipment and machinery purchases, effective for property placed in service after September 8, 2010 and through December 31, 2011. For property placed in service in 2012, the new law provides for 50% additional first-year depreciation.
Estate taxes are reinstated for 2011 and 2012, with an exemption of $5 million per person and a top rate of 35%. Estates of people who died in 2010 can elect to follow the estate tax rules of either 2010 (no estate tax, but with a “carryover” of a decedent’s tax basis) or 2011 (estate tax with a full “step-up” in tax basis to an asset’s fair market value at the decedent’s date of death).
The Gift Tax Exemption was $1 million prior to 2011. With this lower exemption, if a taxpayer’s cumulative lifetime gifts exceeded this $1 million mark, then they would be required to pay gift taxes. Now, the has be “re-unified” with the estate tax, meaning that the current gift tax exemption is the same amount as the estate tax exemption – i.e. $5 million. Like the changes which the Act makes to the estate tax, this change expires at the end of 2012. This means that for 2011 and 2012, taxpayers have an unprecedented opportunity to make larger estate-planning gifts without paying gift taxes.
“Portability” is the latest buzzword for the estate tax. New provisions in the Act allows surviving spouses to add their deceased spouses unused estate tax exemption to their own, potentially allowing the surviving spouse to ultimately have $10 million of estate tax exemption. However, this new provision may have limited application. First, the provision will only apply if the first spouse dies after January 1, 2011 and the second spouse dies before December 31, 2012. While Congress may extend this provision, that result is far from certain. Second, the exemption will be lost if the surviving spouse remarries and survives his or her next spouse. Ultimately, we suggest that the traditional use of a “bypass trust” continue to be the first line of defense against the estate tax.
While the new tax bill certainly has benefits to taxpayers and does provide some planning opportunities, because of the fleeting nature of many of the provisions in the bill, planning around some of the bill’s provisions will be a somewhat precarious process.
The new Congress is already discussing additional “tax reform.” Stay tuned!