A Summary of The New Tax Bill

Both the House and Senate have passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, and the bill is expected to pass into law soon. What goodies does it hold for taxpayers?

With so much uncertainty around how the tax bill would fare in Congress, I resisted blogging about resulting changes until now.  Since the President negotiated the bill, his intention to sign it is not in doubt.  As the name indicates, the bill covers more than taxes, but for now I’d like to focus on some of its key implications for taxpayers.

No Income Tax Rate Increase
The big news, of course, is that income tax rates, set to rise in 2011, will remain at current levels (set by EGTRRA in 2001) until 2012.  Year-end tax planning can be done with the knowledge that rates will not go up next year.

Lower Payroll Taxes (Temporarily)
For 2011 only, the Social Security portion of the employee’s portion of the payroll tax has been reduced from 6.2% to 4.2%.  Taxpayers who have reached the income limit for FICA taxation ($106,800 in 2011) will receive about $2,100 more in take-home pay as a result.

Education Tax Breaks
The American Opportunity tax credit, providing breaks for college costs, is available to individuals with modified adjusted gross income of $80,000 or less ($160,000 or less for joint filers).  The credit, worth up to $2,500, has been extended through 2012.

Coverdell Education Savings account benefits were slated to change in 2011 but have been extended for two years.  Maximum contributions remain at $2,000/year (this amount was set to drop to $500), and distributions from the accounts can still be used for elementary, secondary, and college education costs for now.  Without this change, qualified distributions would have been limited to college education costs starting in 2011.

2010-2011 AMT Relief for Middle-Class Taxpayers
The Alternative Minimum Tax (AMT) exemption, set to decline, has been extended for two more years.  In 2010, the exemption amounts will be $47,450 for single taxpayers and $72,450 for married couples filing jointly; for 2011 the amounts will rise to $48,450 and $74,450, respectively.  The bill keeps about 20 million taxpayers from being snagged, but does not address the long-term problem that the AMT represents after 2011.

Capital Gains/Dividend Tax Breaks
Maximum income tax rates on long-term capital gains and qualified dividends, scheduled to rise from their historic low of 15%, will remain where they are for more two years.  Without the new law, maximum rates on dividends would have approached 40% and those on long-term capital gains would have gone as high as 20%.  For couples with incomes in the lowest two tax brackets (i.e. income below $69K), the rate for capital gains and qualified dividends remains at 0%.

It was expected that the coming change would have induced many investors to realize their capital gains by selling assets at the end of the year in order to get the lower rate.

Other Deductions/Credits
Under EGTRRA, limits on itemized deductions and personal exemptions for wealthy taxpayers were set to return in 2011; the bill repeals that action through 2012, leaving the full benefits of the deductions/exemptions in place.

The child tax credit, scheduled to drop to $500, will remain at $1,000.  The child and dependent care credit, which was slated to drop to $2,400, stays at $3,000 for two more years.

The ability to choose between deducting state income taxes or state sales taxes has also been extended.

Estate Tax Extension
After a single year of no estate tax, Congress finally managed to extend – temporarily – the estate tax with a rate of 35% and an exemption level of $5 million, to be adjusted for inflation.  Couples will receive a total exemption of $10 million.  The extension covers 2011 and 2012 only, after which the issue will again need to be sorted out.

No 1099 Tax Break for Small Business
Efforts to eliminate the requirement that small businesses start issuing 1099 forms to all vendors to whom they pay $600/year or more were not successful.

The Bad News
Taxpayers can be thankful that some sort of tax relief has been negotiated, but there is one problem this bill doesn’t address.  Since this is a mere two-year extension, there are more temporary provisions in the income tax code now than at any time in history; the long-term standing of all of these provisions remains unclear.  Businesses and individuals can’t make long-term plans and investments when they don’t know what the consequences of those actions will be, so many will tend to postpone any action.

The uncertainty created by this situation does mean that there will be new opportunities to develop clever tax strategies.  I guess that’s good news for people who make their livings by giving tax advice.

About the author

Thomas Fisher, CFP®

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