Sweeping Tax Relief for Businesses and Individuals
On December 17, 2010, the president signed the
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (also known as the Tax Relief Act), extending a variety of tax provisions. The act also provided an important depreciation incentive for businesses and a new 2011 tax break for individuals. And, beginning in 2011, the estate tax is restored, but with an increased exemption and lower rate.
We’ve dissected the legislation, identifying key provisions and strategies for you and your business.
Continuation of individual income tax rates
The new legislation extends the 2010 income tax structure, in its entirety, through 2012. As a result, the present six-bracket individual income tax system, with rates ranging from 10 to 35 percent, continues for two more years. An important feature of this system is the zero-percent capital gain and dividend rate for taxpayers in the two lower brackets, and the 15 percent capital gain and dividend rate for all others.
Personal exemptions and overall itemized deductions are not subject to phaseout for higher-income taxpayers for 2010. These provisions are also extended through 2012.
“The two-year lock in the income tax and capital gain rates provides much-needed certainty for individual and business taxpayers who might be looking to sell land or stock, or exercise stock options,” says Chris Hesse, tax principal with LarsonAllen. He also commented that retaining the income tax rates for two years fits well for those converting IRA accounts to Roth status in 2010 and using the two-year income deferral privilege.
For the last three years, the tax law has allowed businesses to claim a 50 percent first-year deduction for new assets, in an attempt to stimulate the economy by accelerating capital purchases. For 2011, this provision expands to a 100 percent first-year bonus depreciation deduction for new additions of machinery and equipment and certain real estate leasehold improvements. The provision is retroactive and applies to new assets (but not used) placed in service after September 8, 2010. The 100 percent deduction applies throughout 2011, and then drops to 50 percent for calendar year 2012.
Congress has also provided clarification on the Section 179 first-year depreciation deduction for these next two years. Prior legislation had increased the deduction to $500,000 for tax years beginning in 2010 and 2011. This latest law sets the amount at $125,000 for tax years beginning in 2012. For those businesses contemplating equipment and other qualifying assets in the next several years, the Section 179 deduction can be applied to both new and used assets, whereas the 100 percent/50 percent bonus depreciation is limited to new property.
According to Hesse, the 100 percent bonus deduction for 2011 provides substantial benefit to businesses and landlords considering interior improvements to leased buildings. Those considering renovations should check with their tax advisor. “How you structure your transaction can affect whether you take an immediate, full write-off or a deferred deduction over time,” Hesse says.
There is also a front-end deduction opportunity for a business adding a new vehicle, either now before yearend or in 2011. New vehicles over 6,000 pounds can be entirely deducted using 100 percent bonus depreciation, if fully utilized for business.
Although the act extends federal provisions, it’s important to note that “many states do not automatically follow federal income tax law,” says Mike Herold, principal specializing in state and local taxes with LarsonAllen. “The states often stick with older, slower depreciation methods.”
Business provisions extended
Congress has renewed many business tax breaks that expired at the end of 2009, with most extended through 2011. Some of the more widely applicable provisions include:
- The research and development (R&D) tax credit
- The 15-year depreciable period (rather than 39 years) for certain leasehold improvements, restaurant buildings, and interior improvements to retail property
- Enhanced charitable deductions for contributing food to charities, books to public schools, and computer equipment for educational use
The special five-year depreciable recovery period for new farm equipment was not extended. Accordingly, for 2010, any new farm equipment not written off with either the Section 179 deduction or 50 percent/100 percent bonus depreciation is subject to a seven-year recovery period.
“There are planning opportunities with the 15-year restaurant buildings, qualified leasehold improvements, and retail improvements,” Hesse notes. “Those assets can qualify for up to a $250,000 Section 179 deduction through 2011.”
Individual provisions rolled forward
A long list of individual income tax “extenders” (provisions that Congress must renew frequently) have been restored for 2010 and, in general, extended through 2011. Some of the key items include:
- The increased alternative minimum tax (AMT) exemption is extended for both 2010 and 2011.
- Taxpayers age 70½ or older can again direct up to $100,000 of individual retirement account (IRA) funds annually to charity and to count this toward their annual required minimum distribution (RMD). There is a grace period to make this election until January 31, 2011.
- The $1,000 per-child tax credit has been continued.
- An extension of the zero-percent capital gain rate for Section 1202 stock applies to new investments in small business C corporation stock before 2012. The stock must be held five years to achieve the zero rate, and the corporation must be conducting an active business in industries like manufacturing, construction, or the retail/wholesale distribution of goods. But there are technical tax traps associated with forming a C corporation in pursuit of the zero-percent rate; speak with your tax planner before pursuing this.
- Unaltered deductions include the itemized sales tax for those in non-income tax states, the college tuition deduction and credits, and the teacher supplies deduction.
The principal residence energy credit, allowing a federal tax subsidy of up to $1,500, expires December 31, 2010. This credit is computed as 30 percent of the first $5,000 of qualifying expenditures on energy-efficient improvements, such as insulation, doors, windows, furnaces, air conditioners, and water heaters. However, for 2011, a smaller credit is available, computed as 10 percent of eligible expenditures and capped at $500. Further, that cap is a lifetime limit, and must be reduced by any credits claimed under earlier versions in the law from 2005 through 2010.
One individual tax provision not renewed was the extra allowance of up to $500 of real estate taxes for those claiming the standard deduction (or $1,000 if filing jointly). It expired after the 2009 tax year.
Payroll tax cut for 2011
The Social Security tax on the employee share of wages is reduced from 6.2 percent to 4.2 percent for 2011. However, there is no change to the employer share. Also, a similar 2 percent reduction applies for the self-employment tax affecting proprietors and partners. All taxpayers, regardless of income, will receive this boost in take-home earnings for calendar year 2011. For those who reach the maximum of $106,800 of social security earnings, this represents a savings of $2,136. To a $50,000 wage earner, the savings would be $1,000. This savings should appear immediately for paychecks issued after January 1, 2011.
This 2 percent cut is a replacement for the “Making Work Pay” credit that applied to 1040s for 2009 and 2010, providing up to a $400 rebate for single filers and $800 for joint returns.
Estate tax restoration
For 2010 only, there was no federal estate tax. However, beginning in 2011, the estate tax and generation-skipping transfer tax is restored as follows:
- For 2011 and 2012, the per-person estate tax exemption is $5 million, with the rate on any excess amount at a flat 35 percent. In 2009, when the estate tax last applied, the exemption was $3.5 million and the rate was 45 percent.
- For deaths in 2010, there is a choice of retaining the “no estate tax” regime or applying the 2011 estate tax system with the $5 million exemption. This is important practical relief for smaller estates for deaths that occurred in 2010, as it avoids the complicated carryover basis rules and reporting that applied under the no estate tax regime. Instead, the heirs simply will receive a full step-up in basis of the assets equal to fair market value under the same rules that existed in the past.
- For gifts after 2010, the gift tax and estate tax exemptions are unified into the single $5 million amount. This allows a greater amount of lifetime gifts than the previous $1 million limitation applicable for 2010.
- Beginning in 2011, the executor of a deceased spouse may transfer any unused portion of the $5 million exemption to the surviving spouse. This is important simplification, assuring that a husband and wife together will have the full use of their combined $10 million exemption amount, regardless of how assets are titled or in what order the deaths occur.
“The increased estate tax exemption and lower rate will be helpful for many small business owners. But we need to recognize that this only provides certainty through December 31, 2012,” Hesse says.
Sue Clark, principal specializing in estate tax with LarsonAllen, observes that the portability of a first spouse’s unused exemption will require more estate tax filings. “In the past, we generally didn’t file if the spouse’s total net worth was beneath the exemption. But now we will need to put on record with the IRS the amount of estate exemption used at the death of the first spouse.”
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