Recent Tax Breaks for Individuals, Estates and Businesses

Nancy Moriarty, – Tax Services

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Act) became law on December 17, 2010. The Act extends the existing federal tax rates for two years and includes a series of other tax breaks. This article summarizes the highlights that will affect individuals, estates, and businesses.

Individual Taxes

Individual Income Tax Rates

Individual income tax rates will remain at the current rates of 10, 15, 25, 28, and 35 percent through 2012. The legislation also extends through 2012 the repeal of the personal exemption phase-out and itemized deduction limitation phase-out.

Capital Gains and Dividends

Currently, taxpayers below the 25% bracket pay no tax on capital gains and qualified dividends, and taxpayers in the 25% bracket and above pay a 15% tax on capital gains and qualified dividends. Beginning in 2011, these rates were set to increase to 10% and 20%, respectively, and all dividends would have been subject to ordinary income tax rates. The Act extends the current capital gains and dividend rates for all taxpayers through 2012.

Alternative Minimum Tax Patch

The Act includes a two year Alternative Minimum Tax (AMT) patch, which increases the 2010 AMT exemption amounts to $47,450 for individuals and $72,450 for married taxpayers. In 2011, the exemption will be $48,450 for individuals and $74,450 for married taxpayers. The Act also allows nonrefundable personal credits (such as the dependent care credit or child credit) to offset AMT liability.

Marriage Penalty Relief and Expanded Dependent Care Credit

The Act extends the marriage penalty relief for the standard deduction, the 15% bracket, and the earned income tax credit through 2012. This ensures that the standard deduction for couples is twice that of single filers, and the amount of income for joint filers in the 15% tax bracket is also twice that of single filers.

The Act also extends the expanded dependent care credits, which allow taxpayers to claim a credit for an applicable percentage of child care expenses for children under 13 and disabled dependents. The amount of eligible expenses and the applicable percentage will remain at their increased amounts through 2012.

Temporary Employee Payroll Tax Cut

The Act reduces the 2011 social security tax rate paid by employees to 4.2% (from 6.2%). For self-employed individuals, the rate is reduced to 10.4% (from 12.4%).

Education Incentives

The American Opportunity Tax Credit is extended through 2012. Under this credit, certain taxpayers receive a credit of up to $2,500 for the cost of tuition and related expenses paid during the year.

Tax-free Distributions from IRAs for Charitable Purposes

The Act extends the provision that allows a tax-free IRA distribution of up to $100,000 per taxpayer per year, to be used as a charitable donation. It also allows individuals to treat charitable transfers made during January 2011 as if they were made in 2010.

Deduction of State and Local Sales Taxes

The Act extends through 2011 the provision that allows taxpayers to elect to deduct state and local sales taxes in lieu of state and local income taxes. This provision benefits taxpayers living in states without an income tax.

Estate and Gift Taxes

Prior to passage of the Act, the estate and generation-skipping transfer taxes (“GST”) were fully repealed in 2010. For gifts made in 2010, the gift tax rate was 35% and the gift tax exemption was $1 million.

The Act sets the gift, estate, and GST tax rate at 35% through 2012 with an exemption of $5 million per individual or $10 million per couple. Under prior law, each of these types of taxes (estate, gift, and GST) had individual rules and were each allowed different exemptions. The Act unifies the estate and gift systems with the 35% tax rate and $5 million exemption applying to both. The exemption amount will be indexed for inflation beginning in 2012. For estates of decedents who die after December 31, 2010, the Act allows any unused exemption amount to be transferred to the surviving spouse.

The Act is effective as of January 1, 2010. Therefore estates of decedents who died in 2010 are also subject to the 35% tax rate and $5 million exemption. However, these estates can elect to have prior law apply. If such an election is made, the estate would not be subject to estate tax and the basis of the assets acquired from the estate would be determined under the modified carryover basis rules.

Business Taxes

Extension of Qualified Small Business Stock Provisions

Qualified small business stock (QSBS) is stock that is issued by a C corporation whose proceeds received from stock issuance plus gross assets do not exceed $50 million. The business must also meet a specific active business requirement. The taxpayer is able to exclude any amount of gain that is the greater of: 1) ten times the basis in the stock, or 2) $10 million of gain from that corporation’s stock. The Act extends the recently passed tax legislation (which allows for 100% tax exclusion on the capital gain of QSBS stock issued through 2011 and held for more than 5 years).

Extension and Increase in Bonus Depreciation

The legislation expands the additional first year depreciation from 50% to 100%, for the cost of qualified property placed in service between September 8, 2010 and January 1, 2012. The provision will return the bonus depreciation deduction to 50% for 2012.

Extension of Section 179 Expenses

Section 179 [of the Internal Revenue Code] allows certain taxpayers to elect to deduct the cost of certain property placed in service for the year, rather than depreciate those costs. The Small Business Jobs Act previously set the expensing limit at $500,000 for years beginning in 2010 and 2011 with an investment phase-out amount of $2 million. The expensing limit was set to revert back to a $25,000 limit for years beginning in 2012. The Act sets the maximum expense amount under Section 179 for years beginning in 2012 to $125,000 and the investment phase-out amount to $500,000.

Extension of the Research Tax Credit

The research tax credit was allowed to expire on December 31, 2009. But the new legislation will extend the tax credit retroactively to cover qualified research expenses made through 2011.