After all the speculation about whether the Bush tax cuts would sunset at year-end or survive into the new decade, Congress, in a politically charged game of beat the clock, finally achieved bipartisan agreement with The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. Signed into law in the waning days of 2010, the Act includes a range of provisions, some significant and many temporary.
Signing Congress’ compromise into law required a significant reversal from President Obama, who had long insisted that the Bush era income tax cuts for couples earning more than $250,000 should sunset. Apparently, the Administration finally accepted the fact that businesses require tax certainty in order to add the jobs necessary to curb unemployment and keep our fragile economy moving forward. Clearly, neither a political stalemate nor an across the board tax increase would fuel job creation.
Highlights of recently enacted Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 include: a welcome two-year extension the Bush era tax cuts; long-overdue certainty in the estate tax arena; and a two-percentage-point cut in employee-paid payroll and self-employment taxes for 2011, to name a few. Additionally, the alternative minimum tax (AMT) has been “patched” for two years and businesses were granted new incentives to invest in machinery and equipment, as well as a credit for spending on research.
Let’s delve into the tax changes in more detail:
- Income tax and capital gains. You will recall 2001’s reduced individual ordinary income tax rates were scheduled to expire at the end 2010. The new law extends those tax brackets (10, 15, 25, 28, 33 and a top rate of 35 percent) for 2011 and 2012. We also retain the favorable 15 percent maximum tax on qualified dividends and long-term capital gains. Of course, if tax rates had been allowed to increase, it may have warranted selling some highly appreciated assets before year-end. With a two year extension of these favorable rates, taking portfolio gains is less urgent. However, it’s still important to avoid all short-term gains and to harvest portfolio losses to offset gains. Remember, you can deduct up to $3,000 of net capital losses from your annual ordinary income and losses above that can be carried over to future years. Particularly because we expect capital gains tax rates to increase in the future, it can make sense to book losses today and carry them into the future when they can offset gains taxed at a higher rate.
- Estate tax. The one-year estate tax hiatus is over; the federal estate tax has been set at a maximum rate of 35 percent for 2010 and 2011, with estates up to $5 million ($10 million for couples) exempt from tax. That $5 million will be indexed for inflation in future years. Interestingly, the new law also retroactively reinstates an estate tax for 2010 at the rate of 35 percent. However, in uncharacteristic flexibility, the government allows executors of estates of decedents who died in 2010 a choice. They can distribute assets to heirs estate-tax-free but with a carryover basis (generally the original purchase price), or step up the basis to the market value (generally at time of death) and pay the current 35 percent rate on anything above the $5 million exemption. A step-up in basis means the value of an appreciated asset is readjusted at a higher market value for tax purposes upon inheritance versus what the value of the asset was when it was originally purchased. Because this is a complex decision for estates over $5 million with highly appreciated assets, executors should consult with their financial advisor, attorney, or tax advisor for advice. And, as you should any time there is a change in estate tax laws, check with your attorney to ensure your will still properly reflects your intentions.
- Social Security payroll tax. Employees and self-employed workers will receive a reduction of two percentage points in Social Security payroll tax in 2011, reducing the rate from 6.2 percent to 4.2 percent for employees, and from 12.4 percent to 10.4 percent for the self-employed individuals. Someone making $40,000 a year would see an extra $800 in his paycheck. What’s the best use of this found money? My choice would be funding an IRA or increasing your 401(k) contributions because tax deferred growth compounds the tax benefits. You should note that the IRS has instructed employers to reduce the amount of Social Security tax withheld as soon as possible, but no later than January 31, 2011. For any Social Security tax over-withheld in January, employers must make offsetting adjustments to an employee’s pay no later than March 31, 2011.
While the tax provisions have received significant attention, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010’s subtitle, Win for Women, Mothers and Working Families, has not received much press. The Act not only continues tax relief, it enacts policies that support working families, particularly women and mothers. For example, the new law extends key provisions including the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC). According to the White House press office, 12 million women represent about 60 percent of the parents benefitting from the EITC and CTC expansions. Noting that families headed by single mothers are among the most economically at risk in our fragile recovery, the Administration’s press releases say the extension of the EITC and CTC directs substantial resources to an estimated 4 million families headed by single mothers.
The Act also secures an extension of unemployment insurance for an additional 13 months. The government estimates that without this extension, 2 million people looking for work would have lost their benefits in December 2010, and, through the end of this year, 7 million people would have lost their benefits. A recent report by the Council of Economic Advisers found that while 14 million people received federally supported unemployment insurance benefits through October 2010, an additional 26 million people living in their households benefitted.
While the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 enacts, or re-enacts, sweeping provisions, remember little is set in stone. With many expirations set for one or two years, we can look forward to another blistering round of political posturing and impassioned debate.