12.13.10

This client alert outlines the presently proposed “compromise” for a two-year extension of current tax rates.  While there is hope that this compromise will pass, changes may occur before ultimate passage.  We will inform you of final passage, if and when, it occurs.

---

President Obama announced on December 6 an agreement with the GOP to extend the Bush-era individual ordinary, capital gain and dividend tax cuts for all taxpayers for two years. The White House-brokered plan would also provide for a one-year payroll tax cut, 100 percent bonus depreciation for 2011, extenders relief, and a top federal estate tax rate of 35 percent with a $5 million portable exclusion. The president’s package is expected to pass Congress before year-end, although certain modifications may be made to garner additional support by key Democrats.

• Impact. The president’s plan gives taxpayers some certainty in tax planning for the next two years. Based on unofficial revenue costs, it also will inject $800 billion into the economy. However, the plan also punts the ultimate fate of the Bush era tax cuts to 2012, a presidential election year.
• Comment. IRS Commissioner Douglas Shulman recently cautioned Congress that the agency needs time to program its computer systems for any changes to the tax law affecting 2010 returns. The IRS also traditionally publishes withholding tables in mid-December. The agency has not yet issued the 2011 withholding tables because of uncertainty over the individual income tax rates and the fate of the Making Work Pay credit.
• Comment. At the time this Tax Briefing was prepared, bill language had not yet been introduced in Congress. House and Senate leaders have scheduled a vote on the president’s package for Monday, December 13, 2010.

Individuals

Ordinary Income Tax Rates

Under current law, the individual income tax rates are scheduled to revert from 10, 15, 25, 28, 33, and 35 percent to 15, 28, 31, 36, and 39.6 percent after December 31, 2010 under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)’s sunset rules. The president’s plan would extend the reduced individual income tax rates for two years, through December 31, 2012.

• Impact. Higher-income individuals also face additional taxes after 2012: a 0.9 percent additional Medicare tax and a 3.8 percent Medicare contribution tax.

Capital Gains/Dividends

Certain long-term capital gains and qualified dividends currently are taxed at a maximum rate of 15 percent (zero percent for taxpayers in the 10 and 15 percent income tax brackets). After 2010, the reduced rates are scheduled to expire. The president’s plan would extend the rate reductions for two years, through December 31, 2012.

• Impact. Without any action on Capitol Hill, the maximum rate on net capital gain will rise to 20 percent in 2011. Of equal if not greater concern to the equities markets and many corporations, the rate on all dividends would rise from 15 percent to being taxed at the regular income tax bracket rates that threaten to reach as high as 39.6 percent. If nothing is done, many investors anticipate a stock selloff at year-end to recognize capital gains before rates increase.

Itemized Deduction Limitation

The “Pease” limitation (named after the member of Congress who sponsored the bill enacting it) reduces the total amount of a higher-income individual’s otherwise allowable deductions. The Pease limitation is repealed for 2010 but is scheduled to return in full after 2010 under EGTRRA’s sunset rules. The president’s plan appears to extend repeal of the Pease limitation for two years, through December 31, 2012.

• Comment. The Pease limitation was gradually repealed starting in 2006 until fully repealed for 2010.

Personal Exemption Phaseout

Before 2010, taxpayers with incomes over certain thresholds were subject to the personal exemption phase out (PEP). The PEP is scheduled to return after 2010 because of EGTRRA’s sunset rules. The president’s plan appears to extend full repeal of the PEP for two years, through December 31, 2012.

Marriage Penalty Relief

EGTRRA provided relief from the so-called marriage penalty by increasing the basic standard deduction for a married couple filing a joint return to twice the amount for a single individual. Under current law, this treatment is scheduled to expire after 2010. The president’s plan would extend marriage penalty relief for two years, through December 31, 2012.

• Comment. EGTRRA also temporarily expanded the size of the 15 percent income tax rate bracket for married couples filing a joint return to help mitigate the marriage penalty. The president’s plan would keep this treatment in place through December 31, 2012.

Child Tax Credit

After 2010, the child tax credit without Congressional action is scheduled to drop from $1,000 per qualified child to $500 per qualified child. Subsequent legislation increased the refundable portion of the child tax credit for 2009 and 2010. The president’s plan would extend the $1,000 child tax credit and the additional enhancements for two years, through December 31, 2012.

Earned Income Credit

EGTRRA and subsequent legislation temporarily increased the beginning and end points of the earned income credit (EIC) and made other taxpayer-friendly changes. The president’s plan would extend the enhanced EIC for two years, through December 31, 2012.

Dependent Care Credit

EGTRRA temporarily increased the maximum amount of eligible employment enabling expenses for the dependent care credit from $2,400 to $3,000 (from $4,800 to $6,000 for more than one qualifying individual) and made other enhancements, all scheduled to expire after 2010. The president’s plan would extend the enhanced dependent care credit for two years, through December 31, 2012.

American Opportunity Tax Credit

The American Recovery and Reinvestment Act of 2009 enhanced and renamed the Hope education credit as the American Opportunity Tax Credit (AOTC). The AOTC is scheduled to expire after 2010 and revert to lower Hope credit levels. The president’s plan would extend the AOTC for two years, through December 31, 2012.

• Impact. Qualified taxpayers with higher education expenses will continue to benefit from an AOTC that is 40 percent refundable. Still unclear based upon the White House announcement is the fate of the higher education tuition deduction of up to $4,000, which expired at the end of 2009.

Alternative Minimum Tax

An AMT “patch” also would be part of the president’s package. The patch is intended to prevent the AMT from encroaching on middle income taxpayers by providing higher exemption amounts and other targeted relief for 2010 and 2011. Without this patch, which had expired at the end of 2009, an estimated 21 million additional households would be subject to its reach.

• Impact. Without a patch for 2010, the exemption amounts for 2010 and again for 2011 will plummet to $33,750 for unmarried individuals filing a single return, $45,000 for married couples filing a joint return and surviving spouses, and $22,500 for married individuals filing a separate return. The exemption amounts under the 2009 patch were $46,700 for unmarried individuals filing a single return, $70,950 for married couples filing a joint return and surviving spouses, and $35,475 for married couples filing a separate return.

Individual Tax Extenders

Some popular but temporary individual tax incentives expired at the end of 2009. They include the state and local sales tax deduction, the teacher’s classroom expense deduction and the higher education tuition deduction. At the time this Tax Briefing was prepared, it was unclear which of the individual extenders would be included in the final bill.

Unemployment compensation

One of the key provisions conceded to the president by the GOP in negotiations of the tax package was an extension of federal unemployment benefits through 2011. The 2009 Recovery Act had allowed individuals to exclude the first $2,400 in unemployment benefits from income for 2009. Unemployment benefits have been fully taxed in 2010 and do not appear to be excluded from income in the White House plan for 2011.

Payroll Tax Cut

The Making Work Pay credit allows a credit against income tax in an amount equal to the lesser of 6.2 percent of the individual’s earned income or $400 ($800 for married couples filing jointly), subject to income limitations. The credit is scheduled to expire after 2010. The president’s plan does not renew the Making Work Pay credit but, in its place, provides for a one-year, two percent reduction in OASDI tax for wage earners, from 6.2 percent to 4.2 percent.

• Impact. The new payroll tax holiday is estimated to inject $120 billion into the economy in 2011. Unlike the Making Work Pay credit, the two percent OASDI reduction is available to all wage earners, with no phase out limit irrespective of income level. Thus, individuals earning at or above the OASDI cap of $106,800 will receive a $2,136 tax benefit in 2011.
• Impact. The White House explained that the cut is “employee-side” indicating that the incentive will increase take home pay. The employer’s share of OASDI would remain at 6.2 percent. Also not mentioned in the initial White House announcement is any accommodation to provide a similar tax break to those who are self-employed.
• Impact. The two percent reduction in OASDI tax is expected to be easier to administer compared with the Making Work Pay credit. When the IRS revised the withholding tables for the Making Work Pay credit, the impact of the credit reached beyond wage earners and negatively affected some pension recipients.

Federal Estate Tax

EGTRRA abolished the federal estate tax for decedents dying on or after January 1, 2010 and on or before December 31, 2010. In its place, a carryover basis regime applies but only for 2010. Pre-EGTRRA estate tax rates (and certain gift tax and generation skipping transfer (GST) tax provisions) are scheduled to return after 2010. The president’s compromise plan with the GOP would provide for a maximum estate tax rate of 35 percent and a $5 million exclusion amount for two years, through December 31, 2012.

• Impact. At the time this Tax Briefing was prepared, the White House had only outlined the general parameters of the estate tax proposal. It is unclear if the 35 percent rate and the $5 million exclusion amount would be made available to decedents dying in 2010 as an option. Questions have also been raised about portability. It is believed that decedents dying in 2010 will have the option to use the 2011 tax law and that the exclusion amount will be portable.
• Impact. The $5 million exclusion amount is a significant jump from the $3.5 million amount that already passed the House and may trigger some resistance on Capitol Hill to the overall package.

Business Incentives

100 Percent Bonus Depreciation

In October, President Obama proposed to boost 50-percent bonus depreciation to 100 percent for qualified investments made between September 8, 2010 and the end of 2011. The president’s plan now includes a similar provision but limited to investments made in 2011.

• Impact. This provision is one of the most expansive for businesses. Unlike section 179 expensing, it is not limited to use by smaller businesses or capped at a certain dollar level.

Research Tax Credit

The Code Sec. 41 research tax credit expired at the end of 2009. President Obama has urged Congress to make the credit permanent. The president’s plan includes a temporary two-year extension of the credit.

Business Tax Extenders

Many business tax extenders expired at the end of 2009. At the time this Tax Briefing was prepared, it appeared that the president’s plan includes extending some, and possibly all, of the expired business tax incentives.

• Comment. The list of expired business tax extenders is long and has grown in recent years as lawmakers add incentives targeted to specific industries. A long list of special interest business extenders resulting in a “Christmas tree” bill could delay passage of the president’s plan.
• Comment. It is also unclear if the president’s plan would extend some expiring energy tax incentives. Some are targeted to individuals; many to producers of alternative fuels.

If you are interested in discussing how this affects your company, we would be glad to advise you.

Download Document »

« Back to all Publications