New Tax Law
Major New Tax Law Recently Enacted
Richard Scrivanich - Partner, December 21, 2010Dear Client:
On December 17, 2010 the President signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act). The 2010 Tax Relief Act extends for two years the Bush-era tax cuts, retains for two years favorable tax rates for long-term capital gains and qualified dividends, provides significant estate and gift tax relief, and includes a two-year AMT "patch." It also contains new tax breaks, including 100% first-year write-offs of qualifying property placed in service after September 8, 2010 and before January 1, 2012, and a payroll/self-employment tax cut of two percentage points for 2011 for employees and self-employed individuals. Plus it extends a host of expired and expiring tax breaks for businesses and individuals as well as a number of key disaster relief provisions. Below is a summary of some of the major provisions included in the 2010 Tax Relief Act.
Under pre-Act law, the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), other than those made permanent or extended by subsequent legislation, were set to sunset and no longer apply to tax or limitation years beginning after 2010. Beginning in 2011, the EGTRRA sunset would have wiped out a host of favorable tax rules, such as: favorable income tax rate structure for individuals; marriage penalty relief; and liberal education-related deduction rules. Similarly, under the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), as modified by Sec. 102 of P.L. 109-222, the favorable tax treatment of long-term capital gain and qualified dividends would have ended after 2010.
The alternative minimum tax (AMT) exemption amounts were "temporarily" increased for four years by EGTRRA, and then "temporarily" increased again by a succession of tax laws. The ability of individuals to use most nonrefundable personal credits to offset AMT also is "temporary," and has been extended over the years by a series of new laws. Under pre-Act law, after 2010, the AMT exemption amounts were to have plummeted to their pre-EGTRRA level, and individuals would not have been able to use most nonrefundable personal credits to offset AMT.
Finally, the American Recovery and Reinvestment Act of 2009 (ARRA) temporarily boosted the credit incentives for higher education (i.e., created the American Opportunity Tax Credit, or AOTC), and liberalized the rules for the refundable child tax credit and the earned income tax credit (EITC). Under pre-Act law, these ARRA incentives would have ended on December 31, 2010.
Under 2010 Tax Relief Act the EGTRRA and ARRA sunsets are extended for two years. Thus, all of the favorable tax rules explained below remain in place only through 2012. Unless Congress acts, these favorable rules will revert to their pre-EGTRRA and pre-ARRA rules.
Reduced Tax Rates Extended for Two Years. Under the 2010 Tax Relief Act, the tax rate schedules for individuals will remain at 10%, 15%, 25%, 28%, 33% and 35% for two additional years, through 2012. Without this change, the rates were scheduled to rise to 15%, 28%, 31%, 36% and 39.6% beginning in 2011.
No 3%/80% Limitation on Itemized Deductions for 2011 and 2012. Unless a taxpayer elects to claim the standard deduction, a taxpayer is allowed to deduct his itemized deductions (generally those deductions which aren't allowed in computing adjusted gross income). For tax years beginning in 2010, there was no overall limitation on itemized deductions based on the taxpayer's adjusted gross income (AGI), although separate limitations (floors) might apply to the particular deduction. Under the 2010 Tax Relief Act, the itemized deductions of higher-income taxpayers are not reduced for two additional years, through 2012. Without this change, for tax years beginning after December 31, 2010, the total amount of itemized deductions was to be reduced (the "Pease limitation") by 3% of the amount by which the taxpayer's AGI exceeds a threshold amount ($169,550 for 2011), with the reduction not to exceed 80% of the otherwise allowable itemized deductions.
No Phase-Out of Personal Exemptions for 2011 and 2012. Personal exemptions generally are allowed for the taxpayer, his or her spouse, and any dependents. For tax years beginning in 2010, there was no overall reduction in the personal exemption amount based on the taxpayer's AGI. Under the 2010 Tax Relief Act, a higher-income taxpayer's personal exemptions are not phased out for two additional years (for 2011 and 2012) when AGI exceeds an inflation-adjusted threshold. Under pre-Act law, for tax years beginning after December 31, 2010, the total amount of exemptions that could be claimed by a taxpayer was to be reduced (personal exemption phase-out (PEP)) by 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold (in 2011, $169,550 for unmarried individuals; $254,350 for married couples filing joint returns; $211,950 for heads of household.). The phase-out rate was to be 2% for each $1,250 for married taxpayers filing separate returns.
Reduced Capital Gains and Qualified Dividends Rate Extended for Two Years.
Capital gain. For tax years beginning in 2010, for both regular tax and AMT purposes, the maximum rate of tax on the adjusted net capital gain of an individual is 15%. If the adjusted net capital gain would otherwise be taxed at a rate below 25% if it were ordinary income, it is taxed at a 0% rate. That part of net capital gain attributable to unrecaptured section 1250 gain is taxed at a maximum rate of 25%. Net capital gain attributable to collectibles gain and section 1202 gain is taxed at a maximum rate of 28%. Under the 2010 Tax Reform Act, adjusted net capital gain will continue to be taxed at a maximum rate of 0%/15% for two additional years, through 2012. In addition, any gain from the sale or exchange of property held more than five years that would otherwise have been taxed at the 10% capital gain rate would be taxed at an 8% rate. Any gain from the sale or exchange of property acquired after 2000 and held for more than five years, that would otherwise have been taxed at a 20% rate was to be taxed at an 18% rate. Net capital gain attributable to collectibles gain and section 1202 gain was to continue to be taxed at a maximum rate of 28%. Without this change, for tax years beginning after December 31, 2010, the maximum rate of tax on an individual's adjusted net capital gain was to be 20%. Any adjusted net capital gain which otherwise would be taxed at the 15% rate was to be taxed at a 10% rate.
Qualified dividend income. For tax years beginning in 2010, for both the regular tax and AMT purposes, an individual's qualified dividend income is taxed at the same rates that apply to net capital gain. Thus, an individual's qualified dividend income is taxed at a 15% and (for qualified dividend income which otherwise would be taxed at a 10% or 15% rate if the special rates did not apply) at a zero rate. Under the 2010 Tax Reform Act, a qualified dividend paid to individuals will continue to be taxed at the same rates. Without this change, for tax years beginning after December 31, 2010, dividends received by an individual were to be taxed at ordinary income tax rates.
Expanded Child Tax Credit Extended for Two Years. For tax years beginning in 2010, individuals may claim a maximum $1,000 child tax credit for each qualifying child under age 17 that the taxpayer can claim as a dependent and can offset both the regular tax and AMT. Also, depending on certain factors, this credit is refundable. Under the 2010 Tax Reform Act, the $1,000 child tax credit is extended and allowed to be used against regular income tax and the AMT for two years, through 2012. Under pre-Act law, for tax years beginning after December 31, 2010, the maximum credit was to drop from $1,000 to $500, and the credit was not to be allowed against AMT. In addition, more restrictive rules were to apply before the child credit would be refundable.
Expanded Dependent Care Tax Credit Extended Two Years. A dependent care tax credit may be claimed in 2010 by an individual who has one or more qualifying individuals and incurs employment-related expenses enabling him to be gainfully employed. For 2010, the maximum dependent care tax credit is $1,050 (35% of up to $3,000 of eligible expenses) if there is one qualifying individual, and $2,100 (35% of up to $6,000 of eligible expenses) if there are two or more qualifying individuals. The 35% credit rate is reduced, but not below 20%, by one percentage point for each $2,000 (or fraction of) AGI above $15,000. Thus, the credit percentage is reduced to 20% of eligible expenses for taxpayers with AGI over $43,000. Under the 2010 Tax Reform Act, these more liberal dependent care tax credit rules apply for two additional years, through 2012. Without this change, for tax years beginning after December 31, 2010, the level of the credit was to be reduced: the maximum credit percentage was to drop from 35% to 30% and the AGI-based percentage reduction was to begin at $10,000 instead of $15,000. The creditable expense was to drop from $3,000 to $2,400 (for one qualifying individual) and from $6,000 to $4,800 (for two or more).
Numerous Education Incentives Extended Two Years.
American Opportunity Tax Credit. For tax years beginning in 2010, individuals may claim an American Opportunity Tax Credit (AOTC) equal to 100% of up to $2,000 of qualified higher-education tuition and related expenses (including course material), plus 25% of the next $2,000 of expenses paid for education furnished to an eligible student in an academic period-i.e., a maximum credit of $2,500 a year for each eligible student. For 2010, the availability of the credit phases out ratably for taxpayers with modified AGI of $80,000 to $90,000 ($160,000 to $180,000 for joint filers). The AOTC (which expanded the credit available under the Hope Scholarship Credit) is allowed for each of the first four years of the student's post-secondary education in a degree or certificate program. The credit can be claimed against AMT liability; and 40% of the otherwise allowable AOTC is refundable (unless the taxpayer claiming the credit is a child under age 18 or a child under age 24 who is a student providing less than one-half of his support, who has at least one living parent, and doesn't file a joint return). Under the 2010 Tax Relief Act, the AOTC rules are extended for two years, through 2012.
Without this change, for tax years beginning after December. 31, 2010, instead of the AOTC an individual was to be able to claim a Hope credit up to a maximum of $1,800. For each eligible student, the Hope credit would be allowed only for expenses paid for the first two years of the post-secondary education, and it phased out ratably for taxpayers with lower specified (inflation adjusted) modified AGI.
Exclusion for scholarships. For 2010, a qualified individual can exclude from income a qualified scholarship or qualified tuition reductions. These exclusions generally do not apply to any amounts received by a student that are payment for teaching, research, or other services as a condition for receiving the scholarship or tuition reduction. Under the 2010 Tax Relief Act, the NHSC Scholarship Program and the Armed Forces Scholarship Program rules are extended for two years, through 2012.
Without this change, for tax years beginning after December 31, 2010, an exception to the no payment for teaching, research, or other services rule for the National Health Service Corps (NHSC) Scholarship Program and the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance Program (Armed Forces Scholarship Program) was to no longer apply.
Employer-provided educational assistance. For 2010, an employee may exclude educational assistance provided under an employer's qualified educational assistance program, up to an annual maximum of $5,250. The education received need not be job-related. Under the 2010 Tax Relief Act, the exclusion for employer-provided educational assistance is extended for two years, through 2012.
Without this change, for tax years beginning after December 31, 2010, the specific exclusion for employer-provided educational assistance was no longer to apply, so that educational assistance would be excludable from gross income only if it qualifies as a working condition fringe benefit (i.e., the expenses would have been deductible as business expenses if paid by the employee; such expense must be related to the employee's current job).
Student loan interest deduction. For 2010, individuals can deduct a maximum of $2,500 annually for interest paid on qualified higher education loans. For 2010, the deduction phases out ratably for taxpayers with modified AGI between $60,000 and $75,000 ($120,000 and $150,000 for joint returns). Under the 2010 Tax Relief Act, the student loan interest deduction rules are extended for two years, through 2012.
Without this change, for tax years beginning after December 31, 2010, the phase-out ranges were to revert to a base level of $40,000 to $55,000 ($60,000 to $75,000 for joint returns), adjusted for inflation occurring since 2002. In addition, the interest was not to be deductible beyond the first 60 months that interest payments are required.
Coverdell education savings accounts. For 2010, taxpayers can contribute up to $2,000 per year to Coverdell Education Savings Accounts (CESAs) for beneficiaries under age 18 (and, special needs beneficiaries of any age). The account is exempt from income tax, and distributions of earnings from CESAs are tax-free if used for qualified education expenses. The contribution limit is phased out for contributors with modified AGI between $95,000 and $110,000 ($190,000 and $220,000 for joint returns). Under the 2010 Tax Relief Act, the Coverdell education savings accounts rules are extended for two years, through 2012.
Without this change, for tax years beginning after December 31, 2010, the following were to apply: a $500 contribution limit; a phase-out range of $150,000 - $160,000 for joint returns; elementary and secondary education expenses excluded from qualified expenses; and no special age rules for special needs beneficiaries. In addition, provisions covering the following were to expire: clarification that corporations and other entities were permitted to make contributions, regardless of the income of the corporation or entity during the year of the contribution; certain rules on when contributions were deemed made and extending the time during which excess contributions could be returned without additional tax; certain rules on coordination with the Hope and Lifetime Learning credits; and certain rules on coordination with qualified tuition programs.
Boosted AMT Exemption Amounts for 2010 and 2011.
The alternative minimum tax (AMT) is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is subject to an AMT rate of 26% or 28%. The 2010 Tax Reform Act patches (i.e., temporarily increases) the AMT exemption amounts for 2010 and 2011. Without this change, the AMT exemption amounts would have reverted to their pre-EGTRRA level.
Bonus Depreciation Extended and Temporary 100% Deduction in Placed-in-Service Year.
Under pre-Act law, the additional first-year depreciation deduction (also called bonus first-year depreciation) is allowed equal to 50% of the adjusted basis of qualified property acquired and placed in service before January 1, 2011 (before January 1, 2012 for certain longer-lived and transportation property). The additional first-year depreciation deduction is allowed for both regular tax and alternative minimum tax purposes (AMT). The basis of the property and the depreciation allowances in the year of purchase and later years are appropriately adjusted to reflect the additional first-year depreciation deduction. A taxpayer may elect out of additional first-year depreciation for any class of property for any taxable year.
In general, an asset qualifies for the bonus depreciation allowance if:
- It falls into one of the following categories: property to which the modified accelerated cost recovery system (MACRS) rules apply with a recovery period of 20 years or less; computer software; and qualified leasehold improvement property; or certain water utility property.
- It is placed in service before Jan. 1, 2011. (Certain long-production-period property and certain transportation property may be placed in service before Jan. 1, 2012.)
- Its original use commences with the taxpayer. Original use is the first use to which the property is put, whether or not that use corresponds to the taxpayer's use of the property. In other words, the property must be new property in the hands of the taxpayer.
The 2010 Tax Relief Act extends and expands additional first-year depreciation to equal:
- 100% of the cost of qualified property placed in service after September 8, 2010 and before January 1, 2012 (before January 1, 2013 for certain longer-lived and transportation property). For example, under the temporary 100% first-year write-off, a calendar-year business that buys $1 million-worth of new bonus-depreciation-eligible property this month will be able to claim a $1 million depreciation deduction for it-that is, completely write it off-on its 2010 return. Noteworthy, is the fact that property is eligible for the new 100% first-year write-off only if it's new.
- 50% of the cost of qualified property placed in service after December 31, 2011 and before January 1, 2013 (after December 31, 2012 and before January 1, 2014 for certain longer-lived and transportation property).
The 2010 Tax Relief Act also extends through 2011 the rule treating qualified leasehold improvement property as 15-year property. Thus, such property is also eligible for a 100% first-year write-off if placed in service after September 8, 2010 and before January 1, 2012, unless it is qualified restaurant or retail improvement property.
First-Year Depreciation Cap for 2011 and 2012 Autos and Trucks Boosted by $8,000.
Under the luxury auto dollar limits, depreciation deductions that can be claimed for passenger autos are subject to dollar limits that are annually adjusted for inflation. For passenger automobiles placed in service in 2010, the adjusted first-year limit is $3,060. For light trucks or vans, the adjusted first year limit is $3,160. Light trucks or vans are passenger automobiles built on a truck chassis, including minivans and sport-utility vehicles (SUVs) built on a truck chassis that are rated at 6,000 points gross (loaded) vehicle weight or less.
The applicable first-year depreciation limit is increased by $8,000 (not indexed for inflation) for any passenger automobile that is "qualified property" under the bonus depreciation rules and which isn't subject to a taxpayer election to decline bonus depreciation.
Under pre-Act law, qualified property didn't include property placed in service after December 31, 2010 (except for certain aircraft and certain long-production-period property that had, instead, a December 31, 2011 placed-in-service deadline).
The 2010 Tax Relief Act provides that the placed-in-service deadline for "qualified property" is December 31, 2013 (December 31, 2014 for the aircraft and long-production-period property). Thus, for a passenger auto that is qualified property under (and isn't subject to the election to decline bonus depreciation and AMT depreciation relief), the Act extends the placed-in-service deadline for the $8,000 increase in the first-year depreciation limit from December 31, 2010 to December 31, 2012.
Boosted Expensing Amounts for 2012.
Under the tax rules, a taxpayer, other than an estate, trust, and certain noncorporate lessors, can elect to deduct as an expense, rather than to depreciate, up to a specified amount of the cost of new or used tangible personal property placed in service during the tax year in the taxpayer's trade or business. The maximum annual expensing amount generally is reduced dollar-for-dollar by the amount of property placed in service during the tax year in excess of a specified investment ceiling. The amount eligible to be expensed for a tax year can't exceed the taxable income derived from the taxpayer's active conduct of a trade or business. And any amount that is not allowed as a deduction because of the taxable income limitation may be carried forward to succeeding tax years.
For tax years beginning in 2010 or 2011: (1) the dollar limitation on the expense deduction is $500,000; and (2) the investment-based reduction in the dollar limitation starts to take effect when property placed in service in a tax year exceeds $2,000,000 (beginning-of-phase-out amount). Amounts ineligible for expensing due to excess investments in expensing-eligible property can't be carried forward and expensed in a subsequent year. Rather, they can only be recovered through depreciation. Under pre-Act law, for tax years beginning after 2011, there's a $25,000 dollar limit on expensing and a $200,000 beginning-of-phase-out amount.
In general, property is eligible for expensing if it is:
- tangible property that's generally, machinery and equipment, depreciated under the MACRS rules;
- for any tax year beginning in 2010 or 2011, up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property); and
- off-the-shelf computer software, but under pre-Act law, only if placed in service in a tax year beginning before 2012.
Under pre-Act law, for tax years beginning before 2012, an expensing election or specification of property to be expensed may be revoked without IRS's consent, but, if revoked, can't be re-elected.
For tax years beginning in 2012, the 2010 Tax Relief Act increases the maximum expensing amount from $25,000 to $125,000 and increases the investment-based phase-out amount from $200,000 to $500,000. The $125,000/$500,000 amounts will be indexed for inflation. However, for tax years beginning after 2012, the maximum expensing amount drops to $25,000 and the investment-based phase-out amount drops to $200,000.
The Act also provides that off-the-shelf computer software is expensing eligible property if placed in service in a tax year beginning before 2013 (a one-year extension). Finally, it provides that for tax years beginning before 2013 (also a one-year extension), an expensing election or specification of property to be expensed may be revoked without IRS's consent. But, if such an election is revoked, it can't be re-elected.
Temporary Employee/Self-Employed Payroll Tax Cut for 2011.
The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers-one for Old Age, Survivors and Disability Insurance (OASDI; commonly known as the Social Security tax), and the other for Hospital Insurance (HI; commonly known as the Medicare tax).
Under pre-Act law, the FICA tax rate for employees and employers is 7.65% each-6.2% for OASDI and 1.45% for HI. Under the Self Employment Contributions Act (SECA) tax, self-employment income of self-employed taxpayers is subject to a tax of 15.3%-12.4% for OASDI and 2.9% for HI. There is a maximum amount of compensation subject to the OASDI tax (the wage base), but no maximum for HI. The wage base is $106,800 for 2010 and 2011.
Under pre-Act law, for computing the income tax of an individual, allows an above-the-line deduction equal to 50% of the amount of the SECA tax imposed on the individual's self-employment income for the tax year.
For remuneration received during 2011, the 2010 Tax Relief Act reduces the employee OASDI tax rate under the FICA tax by two percentage points to 4.2%. Similarly, for self-employment income for tax years beginning in 2011, the Act reduces the OASDI tax rate under the SECA tax by two percentage points to 10.4% percent. As a result, for 2011, employees will pay only 4.2% Social Security tax on wages up to $106,800 and self-employed individuals will pay only 10.4% Social Security self-employment taxes on self-employment income up to $106,800. Thus, the maximum savings for 2011 will be $2,136 (2% of $106,800) per taxpayer. If both spouses earn at least as much as the wage base, the maximum savings will be $4,272.
Overview of relief. Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), there was no estate tax for decedents dying in 2010, but estate and other transfer taxes were scheduled to rise substantially for post-2010 transfers. The 2010 Tax Relief Act provides temporary relief. It reduces estate, gift and generation-skipping transfer taxes for 2011 and 2012 and continues a host of other estate and gift tax relief provisions that were set to expire after this year. It preserves estate tax repeal for 2010, but in a roundabout way. Estates wanting zero estate tax for 2010 must elect that option, along with the modified carryover basis rules that were set to apply for this year. Otherwise, by default, the estate tax is revived for 2010, with a $5 million exemption and a step-up in basis. In a totally new provision, the Act allows a deceased spouse's unused estate tax (but not the GST) exemption to be shifted to the surviving spouse. However, these generous rules, which are discussed in greater detail below, are temporary-much harsher rules are slated to return after 2012.
Background on EGTRRA Transfer Tax Changes. An understanding of the EGTRRA provisions is crucial to understanding the 2010 Tax Relief Act's changes. EGTRRA repealed the estate tax and the generation-skipping transfer (GST) tax for estates of individuals dying in 2010. However, to comply with budgetary rules, EGTRRA contained a so-called "sunset rule" under which the pre-EGTRRA rules were to return after 2010.
Under pre-EGTRRA law, there was no gift tax and no estate tax on the first $675,000 of combined transfers during life or at death for gifts made and individuals dying in 2001. These two taxes were tied together under a unified system having a top rate of 55%. However, there were differences between the gift tax and the estate tax. One difference potentially affected the income tax of donees (recipients) of gifts and heirs of estates. A donee generally gets the donor's basis (usually cost) for a gift. As a result of this carryover basis, if there is a gift of appreciated stock, for example, the donee will have a taxable gain if he sells at the gift value. Property acquired from a decedent, however, generally gets a basis equal to its value at his death. This means that, on a later sale by the heir, he won't have to pay income tax on the appreciation in the property that occurred while it was held by the decedent.
Other changes brought about by EGTRRA were as follows:
- EGTRRA substantially increased the $675,000 exemption in stages after 2001. For individuals dying in 2006 through 2008, the exemption was $2 million. It rose to $3.5 million for individuals dying in 2009.
- EGTRRA also changed the unified system so that the gift tax exemption amount remained at $1 million for all years after 2001. Under the "sunset rule," the exemption was to be $1 million for both estate and gift tax purposes in 2011.
- Under EGTRRA, the top estate and gift tax rate was reduced in stages. It was 45% for transfers in 2007 through 2009. In 2010, there was to be no estate tax and the top gift tax rate was to be 35%. The top estate and gift tax rate was to revert to 55% in 2011.
- For 2010, the basis rules for inherited property were to be similar to the gift tax rules, but with many opportunities for heirs to get increases in basis. For example, these so-called modified carryover basis rules would have permitted the basis of assets received from an individual dying in 2010 to be increased by $1.3 million and by an additional $3 million for assets going to a spouse. Under the sunset rule, the pre-EGTRRA step-up in basis rules were to return for 2011.
- EGTRRA made other changes to the transfer tax rules that also were scheduled to sunset after 2010. For example, it repealed the State death tax credit and replaced it with a deduction. Under the sunset rules, the deduction was to end and the credit was to return in 2011.
- EGTRRA also repealed the qualified family-owned business deduction, which was to return in 2011. It also made modifications to the rules regarding (1) qualified conservation easements, (2) installment payment of estate taxes, and (3) various technical aspects of the GST tax. These modifications were to terminate under the sunset rule.
Increased Exemption and Reduced Top Rate. The 2010 Tax Relief Act lowers estate and GST taxes for 2011 and 2012 by increasing the exemption amount (technically, the applicable exclusion amount) from $1 million to $5 million (as indexed after 2011) and reducing the top rate from 55% to 35%. The $5 million exemption is per person. Thus, there is a $10 million exemption for a married couple. Plus, as explained below, there is a new portability feature for married couples.
Modified Carryover Basis Rules Generally Repealed. The 2010 Tax Relief Act generally repeals the modified carryover basis rules that, under EGTRRA, would apply only for purposes of determining basis in property acquired from a decedent who dies in 2010. Under the Act, a recipient of property acquired from a decedent who dies after December 31, 2009 generally will receive fair market value (i.e., "stepped up") basis under the rules applicable to assets acquired from decedents who died in 2009. However, if an executor chooses no estate tax for a decedent dying in 2010, the modified carryover basis rules apply, as discussed below.
Special Choice for 2010 Decedents. The 2010 Tax Relief Act allows estates of decedents dying in 2010 to choose between (1) estate tax (based on a $5 million exemption and 35% top rate) and a step-up in basis, or (2) no estate tax and modified carryover basis. In technical terms, the Act achieves this choice by making the estate tax and basis changes effective retroactively for estates of decedents dying after 2009, but allowing the opt-out choice for estates of decedents dying in 2010. The executor should make whichever choice would produce the lowest combined estate and income taxes for the estate and its beneficiaries.
Gift Tax Changes. Under the 2010 Tax Relief Act, for gifts made in 2010, the exemption is $1 million and the gift tax rate is 35%. For gifts made after December 31, 2010, the gift tax is reunified with the estate tax, with an applicable exclusion amount of $5 million and a top estate and gift tax rate of 35%.
The Act also makes clarifying changes to how gift taxes are taken into account in the mechanism for computing estate and gift taxes. Under pre-Act law, the gift tax on taxable transfers for a year is determined by computing a tentative tax on the cumulative value of current year transfers and all gifts made by a decedent after December 31, 1976, and subtracting from the tentative tax the amount of gift tax that would have been paid by the decedent on taxable gifts after December 31, 1976 if the tax rate schedule in effect in the current year had been in effect on the date of the prior-year gifts. Under the Act, for purposes of determining the amount of gift tax that would have been paid on one or more prior year gifts, the estate tax rates in effect at the time of the decedent's death are used to compute both (1) the gift tax imposed with respect to such gifts, and (2) the unified credit allowed against such gifts.
Generation-Skipping Transfer Tax Changes. Under the 2010 Tax Relief Act, the GST exemption for decedents dying or gifts made after December 31, 2009 and before January 1, 2011 is equal to the applicable exclusion amount for estate tax purposes (e.g., $5 million). Therefore, up to $5 million in GST tax exemption may be allocated to a trust created or funded during 2010. Although the GST tax is applicable in 2010, the GST tax rate for transfers made during 2010 is 0%. The GST tax exemption for decedents dying or gifts made after December 31, 2010 is equal to the basic exclusion amount (a new concept arising under the portability feature, discussed below) for estate tax purposes (e.g., $5 million, as indexed). The GST tax rate for transfers made in 2011 and 2012 is 35%. The Act extends the EGTRRA modifications to the rules regarding various technical aspects of the GST tax.
Portability of Unused Estate Tax Exemption between Spouses. Under the 2010 Tax Relief Act, any estate tax exemption that remains unused as of the death of a spouse who dies after December 31, 2010 (the "deceased spousal unused exclusion amount") is generally available for use by the surviving spouse, as an addition to the surviving spouse's exemption. A surviving spouse may use the predeceased spousal carryover amount in addition to his or her own $5 million exclusion for taxable transfers made during life or at death. In technical terms, the Act achieves this result for decedents dying and gifts made after 2010 by defining the applicable exclusion amount as the basic exclusion amount ($5 million for 2011, as indexed) plus the deceased spousal unused exclusion amount.
If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by such surviving spouse is limited to the lesser of $5 million or the unused exclusion of the last such deceased spouse.
A deceased spousal unused exclusion amount is available to a surviving spouse only if an election is made on a timely filed estate tax return (including extensions) of the predeceased spouse on which such amount is computed, regardless of whether the estate of the predeceased spouse otherwise must file an estate tax return. In addition, notwithstanding the statute of limitations for assessing estate or gift tax with respect to a predeceased spouse, IRS may examine the return of a predeceased spouse for purposes of determining the deceased spousal unused exclusion amount available for use by the surviving spouse.
Extension of Filing Deadlines. Under the 2010 Tax Relief Act, for a decedent dying after December 31, 2009 and before the enactment date, the due date for certain tax actions is not to be earlier than the date that's nine months after the enactment date. This extension applies for: 1) filing an estate tax return, 2) paying the estate tax, and 3) making any disclaimer of an interest in property passing by reason of the death of such a decedent.
For a generation skipping transfer made after December 31, 2009 and before the enactment date, the due date for filing any return required (including the making of any election required to be made on the return) is not to be earlier than the date that's nine months after the enactment date.
Other EGTRRA Changes Temporarily Continued. The 2010 Tax Relief Act temporarily continues other changes made by EGTRRA for decedents dying after December 31, 2009 and before January 1, 2013, including the deduction for certain death taxes paid to any State or the District of Columbia and modifications to the rules regarding qualified conservation easements and installment payment of estate taxes.
New EGTRRA Sunset. Under the 2010 Tax Relief Act, the sunset of the EGTRRA estate, gift, and GST tax provisions, which was scheduled to apply to the estates of decedents dying, gifts made, or generation-skipping transfers made after December 31, 2010, is extended to apply to estates of decedents dying, gifts made, or generation skipping transfers made after December 31, 2012. The EGTRRA sunset, as extended by the Act, applies to the amendments made by the Act. Therefore, neither the EGTRRA rules nor the new 2010 Tax Relief Act rules will apply to estates of decedents dying, gifts made, or generation-skipping transfers made after December 31, 2012.
Research Credit Reinstated and Extended. The research credit equals the sum of: (1) 20% of the excess (if any) of the qualified research expenses for the tax year over a base amount, (unless the taxpayer elected an alternative simplified research credit); (2) the university basic research credit (i.e., 20% of the basic research payments); (3) 20% of the taxpayer's expenditures on qualified energy research undertaken by an energy research consortium. Under pre-Act law, the research credit didn't apply for amounts paid or accrued after December 31, 2009. The 2010 Tax Relief Act retroactively extends the research credit two years so that it applies for amounts paid or accrued before January 1, 2012.
15-Year Write-off for Qualified Leasehold and Retail Improvements and Restaurant Property Reinstated and Extended. Under pre-Act law, qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property that was placed in service before 2010 was included in the 15-year MACRS class for depreciation purpose-that is, it was depreciated over 15 years under MACRS. The 2010 Tax Relief Act retroactively extends the inclusion of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property in the 15-year MACRS class for two years through 2011.
Expensing of Environmental Remediation Costs Reinstated and Extended. Taxpayers could elect to treat qualified environmental remediation expenses that would otherwise be chargeable to a capital account as deductible in the year paid or incurred. To be deductible currently, such expense had to be paid or incurred in connection with the abatement or control of hazardous substances (including petroleum products) at a qualified contaminated site. Under pre-Act law, the expensing was available for expenses paid or incurred before January 1, 2010. The 2010 Tax Relief Act retroactively extends the expensing provision for two years through 2011.
Work Opportunity Tax Credit Extended. The work opportunity tax credit (WOTC) allows employers who hire members of certain targeted groups to get a credit against income tax of a percentage of first-year wages up to $6,000 per employee ($12,000 for qualified veterans; and $3,000 for qualified summer youth employees). Where the employee is a long-term family assistance (LTFA) recipient, the WOTC is a percentage of first and second year wages, up to $10,000 per employee. Generally, the percentage of qualifying wages is 40% of first-year wages; it's 25% for employees who have completed at least 120 hours, but less than 400 hours of service for the employer. For LTFA recipients, it includes an additional 50% of qualified second-year wages. Under pre-Act law, wages for purposes of the credit doesn't include any amount paid or incurred for an individual who began work after August 31, 2011. The 2010 Tax Relief Act extends the WOTC four months to include individual who began work before January 1, 2012.
Lower Shareholder Basis Adjustments for Charitable Contributions by S Corporations Reinstated and Extended. Before the Pension Protection Act of 2006 (PPA), if an S corporation contributed money or other property to a charity, each shareholder took into account his pro rata share of the fair market value of the contributed property in determining his own income tax liability. The shareholder reduced his basis in his S stock by the amount of the charitable contribution that flowed through to him. The PPA amended this rule to provide that the amount of a shareholder's basis reduction in S stock by reason of a charitable contribution made by the corporation is equal to his pro rata share of the adjusted basis of the contributed property. Under pre-Act law, the PPA rule did not apply for contributions made in tax years beginning after December 31, 2009. The 2010 Tax Relief Act retroactively extends the PPA rule for two years so that it applies for contributions made in tax years beginning before January 1, 2012
All of the following tax breaks for individuals that expired at the end of 2009 or were set to expire at the end of 2010 have been retroactively reinstated and extended through 2011:
- the $250 above-the-line deduction for certain expenses of elementary and secondary school teachers;
- the election to take an itemized deduction for State and local general sales taxes in lieu of the itemized deduction permitted for State and local income taxes;
- increased contribution limits and carryforward period for contributions of appreciated real property (including partial interests in real property) for conservation purposes;
- the above-the-line deduction for qualified tuition and related expenses;
- the provision that permits taxpayers age 70 1/2 or older to make tax-free distributions to charity from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer, per tax year (additionally, individuals will be allowed to treat IRA transfers to charities during January of 2011 and as if made during 2010);
- look-thru of certain RIC stock in determining gross estate of nonresidents; and
- disregard of refunds in the administration of federal or federally assisted benefit programs;
- treatment of mortgage insurance premiums as deductible qualified residence interest; and
- exclusion of 100% of gain on certain small business stock.
The changes caused by the 2010 Tax Relief Act have created year end tax planning opportunities for many individuals and businesses. If you have any questions, or if you would like more information about the specific steps you should implement to take advantage of these favorable changes, please call us at (562)698-9891.