On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Act). The 2010 Act provides for extension of the Bush tax cuts from 2001 and 2003 until 2012, as well as a variety of other tax reductions. Here are the some of the highlights.
Reductions in Individual Income Tax Rates
Temporarily extend the 10% bracket. Under current law, the 10% individual income tax bracket expires at the end of 2010. Upon expiration, the lowest tax rate will be 15%. This 2010 Act extends the 10% individual income tax bracket for an additional two years, through 2012.
Temporarily extend the 25%, 28%, 33%, and 35% brackets. Under current law, the 25%, 28%, 33%, and 35% individual income tax brackets expire at the end of 2010. Upon expiration, the rates become 28%, 31%, 36%, and 39.6% respectively. This 2010 Act extends the 25%, 28%, 33%, and 35% individual income tax brackets for an additional two years, through 2012.
Temporarily repeal the Personal Exemption Phase-out. Personal exemptions allow a certain amount per person to be exempt from tax. Due to the Personal Exemption Phase-out (“PEP”), the exemptions are phased out for taxpayers with AGI above a certain level. The EGTRRA repealed PEP for 2010. The 2010 Act extends the repeal of PEP for an additional two years, through 2012.
Temporarily repeal the itemized deduction limitation. Generally, taxpayers itemize deductions if the total deductions are more than the standard deduction amount. Since 1991, the amount of itemized deductions that a taxpayer may claim has been reduced, to the extent the taxpayer’s AGI is above a certain amount. This limitation is generally known as the “Pease limitation.” The EGTRRA repealed the Pease limitation on itemized deductions for 2010. The 2010 Act extends the repeal of the Pease limitation for an additional two years, though 2012.
Capital Gains and Dividends
Temporarily extend the capital gains and dividend rates. Under current law, the capital gains and dividend rates for taxpayers below the 25% bracket is equal to zero percent. For those in the 25% bracket and above, the capital gains and dividend rates are currently 15%. These rates expire at the end of 2010. Upon expiration, the rates for capital gains become 10% and 20%, respectively, and dividends are subject to the ordinary income rates. This 2010 Act extends the current capital gains and dividends rates for all taxpayers for an additional two years, through 2012.
Temporary Individual Alternative Minimum Tax (AMT) Relief
Two-year AMT patch. Currently, a taxpayer receives an exemption of $33,750 (individuals) and $45,000 (married filing jointly) under the AMT. Current law also does not allow nonrefundable personal credits against the AMT. The 2010 Act increases the exemption amounts for 2010 to $47,450 (individuals) and $72,450 (married filing jointly) and for 2011 to $48,450 (individuals) and $74,450 (married filing jointly). The 2010 Act also allows the nonrefundable personal credits against the AMT. The 2010 Act is effective for taxable years beginning after December 31, 2009.
Estate Tax Relief
Temporary estate, gift and generation skipping transfer tax relief. The EGTRRA phased-out the estate and generation-skipping transfer taxes so that they were fully repealed in 2010, and lowered the gift tax rate to 35 percent and increased the gift tax exemption to $1 million for 2010. The 2010 Act sets the exemption at $5 million per person and $10 million per couple and a top tax rate of 35 percent for the estate, gift, and generation skipping transfer taxes for two years, through 2012. The exemption amount is indexed beginning in 2012. The 2010 Act is effective January 1, 2010, but allows an election to choose no estate tax and modified carryover basis for estates arising on or after January 1, 2010 and before January 1, 2011. The 2010 Act sets a $5 million generation-skipping transfer tax exemption and zero percent rate for the 2010 year.
Portability of unused exemption. Under current law, couples have to do complicated estate planning to claim their entire exemption (currently $7 million for a couple). The 2010 Act allows the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without such planning. The 2010 Act is effective for estates of decedents dying after December 31, 2010.
Reunification. Prior to the EGTRRA, the estate and gift taxes were unified, creating a single graduated rate schedule for both. That single lifetime exemption could be used for gifts and/or bequests. The EGTRRA decoupled these systems. The 2010 Act reunifies the estate and gift taxes. The 2010 Act is effective for gifts made after December 31, 2010.
Temporary Employee Payroll Tax Cut
Temporary reduction in employee-paid payroll taxes. Under current law employees pay a 6.2 percent Social Security tax on all wages earned up to $106,800 (in 2011) and self-employed individuals pay a 12.4 percent Social Security self-employment taxes of on all their self-employment income up to the same threshold. The 2010 Act provides a payroll/self-employment tax holiday during 2011 of two percentage points. This means employees will pay only 4.2 percent on wages and self-employment individuals will pay only 10.4 percent on self-employment income up to the threshold.
As a trust and estate attorney, the portability of the estate tax credit is the most significant feature of the new law. It allows the unused credit of the first spouse to die to be used in the estate of the second to die. This will severely limit the need for complex, tax-driven estate planning for those married couples with assets under $10 million. Instead, other considerations will be paramount, such as asset protection, income tax planning, and trust planning.