On December 17, 2010, President Obama signed into law the 2010 Tax Relief Act which has provisions dealing with income tax, estate tax and unemployment insurance provisions. What is important about this new law is that it is a temporary measure and, for the most part, only impacts 2011 and 2012 – in other words, it is a band aid. All the Bush-era tax cuts which were scheduled to expire in 2010 will now expire at the end of 2012. That’s a pretty scary thought considering that 2012 is a presidential election year and President Obama may be a “lame duck” president without an ability to extend anything past 2012.
Income Tax Provisions
So what is so important about the 2010 Tax Relief Act? Well, for starters, it will keep our existing personal tax rate structure in place (10% to 35%). If this had not passed, the old levels would have been put back into place with rates ranging from 15% to 39.6%. The capital gains tax rates will also remain the same with a zero percent and a 15% rate applying to long term gains and a 15% rate applying to qualifying dividends. If the new law had not passed, the rates would have reverted back to 10% and 20% for long term gains and dividends would have been taxed at ordinary rates instead of the 15% rate.
Anyone who pays withholding taxes should be happy because the social security tax rates are reduced by 2 percentage points which means that the employee portion of the social security taxes is reduced from 6.2% to a temporary rate of 4.2%. This is effective only for 2011. The employer portion will remain the same. Also, the total 15.3% self-employment tax rate is temporarily reduced for 2011 to 13.3%. Self-employed people will still be able to deduct the full amount of the employer’s portion as an adjustment to income.
Finally, alternative minimum tax exemptions have been increased in 2010 and 2011. This will help some middle income earners from being subject to the AMT.
There are several personal tax credits and tax deductions that are also extended through 2012. The tax credits that are extended include the Dependent and Child Care Tax Credit ($3,000 for one child, $6,000 for two or more children), the Adoption Tax Credit, the enhanced Earned Income Credit, the Enhanced Child Tax Credit and the American Opportunity Credit. The tax deductions that are extended include a temporary repeal of the dollar limitation on itemized deductions for higher-income earners, temporary repeal of the phaseout for personal exemptions, deduction for student loan interest, sales tax deduction (which is an optional itemized deduction in lieu of the deduction for state income taxes), and tuition and fees deduction (expires in 2011), classroom expense deduction (through 2011).
Estate Tax Provisions
The 2010 Tax Relief Act affects the rules governing federal estate taxes, gift taxes and generation-skipping transfer taxes for 2010, 2011 and 2012. For those who die in 2011 or 2012, the federal estate tax exemption will be $5 million (it went away for 2010 and was $3.5 million in 2009 and 2008) with the estate tax rate for estates over $5 million being taxed at 35%. The estate tax is also unified with the federal gift tax and generation-skipping transfer tax meaning that the exemption for each is $5 million and the tax rate for both is also 35%.
Something unique to the 2010 Tax Relief Act that we haven’t seen in prior years is the ability “portability” of the federal estate tax exemption between married couples. In 2009 and before, married couples could each pass their federal estate tax exemption (in 2009, that would have been $7 million for a couple) by using a revocable trust that had A/B provisions, also known as credit shelter provisions. The new law allows married couples to add any unused portion of the estate tax exemption for the first spouse to die the surviving spouse’s estate tax exemption. In theory, a married couple should be able to transfer up to $10 million to their heirs free from estate tax without having to use a credit shelter trust. However, it is not exactly clear how this is going to work as this has never been done before. Contact the Law Offices of Laurie Ohall for more information.