In Your Interest

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010

On December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was signed into law. In addition to providing a 13-month extension of benefits for the long-term unemployed, the legislation includes a long-anticipated extension of the “Bush tax cuts” that were scheduled to expire on January 1, 2011. Other significant provisions include a new alternative minimum tax (AMT) “patch,” a major modification of the estate tax, and a new 1-year 2% employee Social Security payroll tax reduction.

Income tax rates

The Act extends existing federal income tax rates for 2 additional years. As in 2010, the federal tax bracket rates for 2011 and 2012 will be 10%, 15%, 25%, 28%, 33%, and 35%. (Without this legislation, federal income tax rates would have increased beginning in 2011–the current 10% federal income tax bracket would have disappeared, and the five remaining tax brackets would have been 15%, 28%, 31%, 36%, and 39.6%.)

Tax rates for long-term capital gain and qualifying dividends

Existing tax rates for long-term capital gains and qualifying dividends are also extended through 2012. As a result, long-term capital gain and qualifying dividends will continue to be taxed at a maximum rate of 15%. For individuals in the 10% or 15% marginal income tax bracket, a special 0% rate will generally continue to apply.

Alternative minimum tax (AMT)

The Act includes another temporary “patch” for the AMT–this one good for 2010 and 2011. AMT exemption amounts are slightly increased, and personal nonrefundable tax credits will be allowed to offset AMT liability through 2011.

Estate tax

The Act makes several major– though temporary– changes to the federal estate tax, including:

• For 2011 and 2012, the estate tax exemption amount (the applicable exclusion amount) will be $5 million per person (the $5 million will be indexed for inflation in 2012); the top estate and gift tax rate for these years will be 35%
• The $5 million exemption amount and 35% top estate tax rate will apply retroactively to 2010 as well, but for individuals who died in 2010, an election can be made to choose the estate tax provisions effective prior to this legislation (i.e., no estate tax, but modified carryover basis rules); an extended due date is provided for individuals who died on or after January 1, 2010, but before December 17, 2010.
• Beginning in 2011, the gift tax (reunified with the estate tax) will have a $5 million dollar exemption amount; the generation-skipping transfer tax, with a $5 million exemption effective January 1, 2010, will have a 0% tax rate for 2010, and a 35% rate for 2011 and 2012
• For 2011 and 2012, when one spouse dies, any unused portion of that spouse’s estate tax exemption amount may be transferred to the surviving spouse

One-year reduction in employee payroll tax

For the 2011 year, the employee portion of the Social Security retirement component of FICA employment tax is reduced by 2%. Normally equal to 6.2% of covered wages up to the taxable wage base ($106,800 in 2011), for 2011 this rate will be reduced to 4.2%. Self-employed individuals, who normally pay 12.4% for the Social Security portion of their self-employment taxes, will also benefit from a 2% reduction, paying the tax at a rate of 10.4% for 2011.

“Bonus” depreciation

The Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009 allowed an additional 50% depreciation deduction for qualifying property placed in service during 2008 and 2009. This additional depreciation deduction was allowed for purposes of the alternative minimum tax (AMT) calculation, as well as regular tax. The Small Business Jobs Act extended the 50% additional first-year depreciation deduction for one year to apply to qualified property acquired and placed in service during 2010.

This Act increases the bonus depreciation percentage to 100% for property acquired and placed in service after September 8, 2010 and before January 1, 2012. The Act extends bonus depreciation at the 50% level through 2012 (50% bonus depreciation will apply for property placed in service after December 31, 2011, and before January 1, 2013).

IRC Section 179 expense limits

Section 179 of the Internal Revenue Code allows businesses to elect to deduct the cost of depreciable tangible personal property acquired for use in the business in the year of purchase, rather than through depreciation deductions. Since 2003, several pieces of legislation have temporarily expanded the limits that apply to Section 179.

Most recently, the Economic Stimulus Act of 2008 and the American Recovery and Reinvestment Act of 2009 increased the maximum amount that can be expensed to $250,000 for tax years beginning in 2008 and 2009. This amount was reduced by the amount by which the cost of qualifying property placed in service during the year exceeded $800,000. For tax years 2010 and 2011, the Small Business Jobs Act increased the maximum amount that may be expensed under Section 179 to $500,000 and increased the phase-out threshold amount to $2 million.

For 2012, the dollar limit amount and phase-out threshold level were scheduled to drop to $25,000 and $200,000, respectively. This Act sets the IRC Section 179 expense limit for 2012 at its 2007 level–$125,000, with a phase-out threshold of $500,000–indexed for inflation.

Small business stock exclusion

Noncorporate investors may generally exclude 50% of any capital gain from the sale or exchange of qualified small business stock (generally, stock issued by domestic C corporations whose assets do not exceed $50 million) issued after August 10, 1993 (if a five-year holding period requirement and other requirements are met). The Small Business Jobs Act temporarily increased the exclusion percentage for qualified small business stock acquired during 2010 to 100%, and does not treat the excluded gain as an alternative minimum tax preference. Therefore, no regular tax or alternative minimum tax is imposed on the sale of qualified small business stock issued and acquired after September 27, 2010, and before January 1, 2011, and held at least five years.

This Act extends the 100% exclusion for one year–to qualifying stock acquired before January 1, 2012, and held for more than five years.

Education provisions

The Act extends the American Opportunity tax credit (known as the Hope tax credit before being significantly– though temporarily–modified by the American Recovery and Reinvestment Act of 2009). The American Opportunity Tax Credit’s higher maximum credit amount, increased income limits, expanded applicability to the first four years of college, and potential refundability, available in 2009 and 2010, are extended through 2012.

The current rules that apply to Coverdell Education Savings Accounts (e.g., $2,000 annual contribution limit, education expenses expanded to include elementary and secondary school expenses) are also extended through 2012. Without this change, the annual contribution limit would have dropped to $500 beginning January 1, 2011.

For the student loan interest deduction, increased income limits and the suspension of the 60-month rule, which would have expired at the end of 2010, are extended for 2 years (the deduction was, prior to 2001, limited to interest paid in the first 60 months of repayment).

The deduction for qualified higher education expenses, which expired at the end of 2009, is retroactively reinstated for 2010, and extended through 2011.

Other provisions–individuals

Provisions extended through 2012 include:

• Itemized deductions and personal and dependency exemptions will not be reduced for higher-income individuals
• “Marriage penalty” relief in the form of an expanded 15% tax bracket and an increased standard deduction amount for married individuals filing jointly
• Exclusion of up to $5,250 in employer-provided education assistance for undergraduate and graduate education
• Increased earned income tax credit (EITC) for families with 3 or more children, and increased EITC income limits for married couples filing jointly
• Increased child tax credit amount with expanded refundability (15% of earnings above $3,000)
• Expanded credit for child and dependent care expenses (increased limit on eligible expenses and maximum credit percentage)
• An increased adoption tax credit and employer-paid adoption assistance exclusion amount; the credit also remains refundable

Provisions retroactively reinstated for 2010 and extended through 2011 include:

• The deduction for state and local sales tax in lieu of state and local income tax on Schedule A
• The $250 above-the-line deduction for elementary school and secondary schoolteacher classroom expenses
• Increased contribution limits and carryforward period for contributions of capital gain property for conservation purposes
• Tax-free distributions to charitable organizations from IRAs by individuals age 70 1/2 or older (up to $100,000 per year); a special provision in the Act allows qualifying individuals to treat a distribution made from an IRA to a charity in January, 2011, as if it were made in 2010

Provisions extended for one year (through 2011):

• Increased monthly exclusion amount for employer-provided transit and vanpool benefits
• Mortgage insurance premiums deductible as qualified residence interest, subject to an adjusted gross income (AGI) limitation

The Act also reinstates the tax credit for energy-efficient improvements to existing homes for 2011, but as it applied prior to the American Recovery and Reinvestment Act of 2009 (e.g., a 10% credit rate generally applies).

Other provisions–businesses

Provisions extended through 2011 include:

• Research and development credit
• Indian employment credit
• New Markets tax credit
• Employer wage credit for activated military reservists
• Enhanced charitable deductions for contributions of food inventory, book inventories, and computer equipment
• Work opportunity tax credit

For high income earners,  there will be  a new 3.8%  Medicare surtax that will be assessed in 2013  on the lesser of:

• Net investment income or
• The excess of “modified adjusted gross income” over the “threshold amount”

Net investment income is the sum of gross investment and includes:

• Interest
• Dividends
• Capital Gains
• Annuities income
• Rents&Royalties

• Passive activity income

Importantly, investment income does not include distributions from IRA’s or other qualified retirement plans.

The taxable income threshold amounts are:

• Married taxpayers filing jointly-$250,000
• Individual Tax Payers-$200,00
• Trusts and Estates $11,200

In sum, if your modified adjusted gross income is below  threshold amounts, then this surtax will not affect you.   However, if your above the threshold you will be taxed to lesser of investment income or excess over MAGI.

This means that combined with the expiration of the Bush Tax cuts, the top federal tax rate in 2013 for investment income can reach 23.8% from the current 15% levels.  Also, qualified  dividend income will  now be treated as ordinary income which will move to 39.6%.

Deep in the weeds of the Health Care reform are a few notable pieces related to college planning.

The first is that the government has cut out the private lenders in the granting of loans and as a result all loans are facilitated directly from the US Government.  This is good news are rates will be a bit lower for parents (The Plus loans) will be  7.9% instead of 8.5% currently being charged by private lenders.

Also, starting in 2014,  the act  limit payments to 10% of discretionary income for the student and will forgive debt after 20 years. Previsously, it was 20% of discretionary income.

Additionally, funds were increased for Pell Grants.  These are funds for the most disadvantaged.

For more information on college planning and financial aid a couple of good websites are

For more information on financial aid and loans, check out:

www.finaid.com

www.savingforcollege.com

Both are top notch sites with good information readily available.

If you’re in the market for a new home and hope to take advantage of the first-time homebuyer tax credit, you’ll need to purchase a principal residence before May 1, 2010 (or before July 1, 2010 if you enter into a written binding contract prior to May 1, 2010). If you–and your spouse, if you’re married–did not own any other principal residence during the three-year period ending on the date of purchase, the credit is worth up to $8,000 ($4,000 if you’re married and file separate returns). If you–and your spouse, if you’re married–have maintained the same principal residence for at least five consecutive years in the eight-year period ending at the time you purchase a new principal residence, the credit is worth up to $6,500 ($3,250 if you’re married and file separate returns).

The credit, however,  is limited to those whose modified adjusted gross income  less than $125,000.  While this can restrict many, it does offer an opportunity for your kids in college.   In many cases, real estate around a college town can be appealing and if your kid will stay in at the college for three years (we hope), there may be an overall benefit of having your college kid purchase a home versus paying rent for 3 or 4  years.   You will have do your homework to see if this can make sense overall in your overall financial planning.

At the beginning of the year, the conventional wisdom was that mortgage rates on the 30 year fixed would drop to around 4.5% at some point and then move higher.  Well, the conventional wisdom was mostly right this time.  They have touched 4.5% this year but have drifted lower in three distinct moves with the most recent hitting record lows last week   Currently the 30 year according to bank rate average around 4.97 with the 15 year fixed at about 4.25%.  To obtain the rates, an average of 1.17% point was charged.  A good source for rates is www.bankrate.com

Many have already refinanced this year, but for those that haven’t now is another opportunity

While most of the talk in Washington centers on health care and Afghanistan, there is a considerable amount of energy focused on financial reform to prevent another “market meltdown” we have seen over the last couple of years.

One piece of the debate is how to regulate advisors, brokers and planners.  Each currently has a different set of rules covering their behavior towards clients.  Brokers are held to a suitability standard which means they need to have a reasonable basis for the recommendation and “know their client.”  Additionally their  advice should be “incidental” to the transaction.   However, Advisors registered with the Securities and Exchange condition are held to a higher “fiduciary” standard that entails the advice be prudent and in the interest of the client.   This topic can be somewhat arcane, but a recent WSJ video does a nice job of pointing out the key differences.

http://link.brightcove.com/services/player/bcpid452319854?bctid=51077511001

Watch for more as congress debates on how best to regulate the advice providers.

A common planning strategy when one has left a company with a large stock position with a low cost basis is to employ Net Unrealized Appreciation (NUA).  This strategy allows for the transfer of the stock from a 401k to a taxable account with the basis in the stock taxed at ordinary income rates and the gain, the net unrealized appreciation, taxed at capital gain rates once the stock is sold.  If you are under 55, you will need to consider the impact of the 10% early withdrawal penalty on the cost basis of the stock.  The additional benefit in this strategy is the flexibility gained in the ability to liquidate the stock position overtime at the beneficial capital gain rates.

However, now according to IRS notice 2009-75 you have an additional choice to consider within the NUA strategy as you can now move the company stock to a Roth IRA.  In this case, the cost basis will be taxed at ordinary income rates, but the Net Unrealized Appreciation will be taxed at capital gain rates at the time of distribution, not when sold as in the above example.  Distributions from these accounts then would be tax free because you already paid ordinary income on the basis and capital gains on the net unrealized appreciation.

Does a Roth NUA strategy make sense?   As a practical matter, probably not.   Many who use the NUA strategy are attracted to the idea of moving money from “tied” up resource to one that allows for more flexibility at a reasonable tax hit.  Nevertheless, the argument can be made that if you have a longer time horizon, or are thinking about the move to a Roth as an estate planning strategy, then the Roth NUA strategy would be something to consider