Fort Wayne, IN CPA / Houlihan, LLP

Dear Client & Friends,

The recently enacted "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010" ("Tax Relief Act of 2010") is a sweeping tax package that includes an extension of the Bush-era tax cuts for two years, estate tax relief, a two-year "patch" of the alternative minimum tax (AMT), a two-percentage-point cut in employee-paid payroll taxes and in self-employment tax for 2011, new incentives to invest in machinery and equipment, and a host of retroactively resuscitated and extended tax breaks for individuals and businesses. Here's a look at the key elements of the package:

Individual Tax

The current income tax rates will be retained for two years (2011 and 2012), with a top rate of 35% on ordinary income and 15% on qualified dividends and long-term capital gains.
Employees and self-employed workers will receive a reduction of two percentage points in Social Security tax in 2011 only, bringing the rate down from 6.2% to 4.2% for employees and from 12.4% to 10.4% for the self-employed.
A two-year AMT "patch" for 2010 and 2011 provides a modest increase in AMT exemption amounts and allows personal nonrefundable credits to offset AMT as well as regular tax..
Extends the $1,000 child tax credit and maintains its expanded refundability for two years, extends rules expanding the earned income credit for larger families and married couples, and extends the higher education tax credit (the American Opportunity tax credit) and its partial refundability for two years.
Extends for an additional year (i.e., through 2011) the rule allowing premiums for mortgage insurance to be deductible as qualified residence interest.
The following tax breaks for individuals that expired at the end of 2009 have been retroactively reinstated by the Tax Relief Act and extended through 2011:

The election to take an itemized deduction for State and local general sales taxes instead of the itemized deduction permitted for State and local income taxes.
The above-the-line deduction for qualified higher education expenses (up to $4000).
The $250 above-the-line tax deduction for teachers and other school professionals for expenses paid or incurred for books, certain supplies, equipment, and supplementary materials used by the educator in the classroom.
The increased contribution limits and carryforward period for contributions of appreciated real property (including partial interests in real property) for conservation purposes.
The provision that permits tax-free distributions to charity from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer, per tax year. Individuals also will be allowed to make charitable transfers during January of 2011 and treat them as if made during 2010.
The increase in the monthly exclusion for employer-provided transit and vanpool benefits to equal that of the exclusion for employer-provided parking benefits.

Business Tax

Businesses can write off 100% of their new equipment and machinery purchases, effective for property placed in service after September 8, 2010 and through December 31, 2011. For property placed in service in 2012, the new law provides for 50% additional first-year depreciation. The new law leaves in place the existing rules as to what kinds of property qualify for additional first-year depreciation. Generally, the property must be (1) depreciable property with a recovery period of 20 years or less; (2) water utility property; (3) computer software; or (4) qualified leasehold improvements. Also the original use of the property must commence with the taxpayer - "used" equipment doesn't qualify
Enhanced small business expensing (Section 179 expensing). The new law makes three important changes to the Code Section 179 expense election: First, the new law provides that for tax years beginning in 2012, a small business taxpayer will be allowed to write off up to $125,000 (indexed for inflation) of capital expenditures subject to a phase-out (i.e., gradual reduction) once capital expenditures exceed $500,000 (indexed for inflation). The new maximum expensing amount and phase-out level for tax years beginning in 2012 is actually lower than the levels in effect for tax years beginning in 2010 or 2011 (maximum expensing amount of $500,000, and a phase-out level of $2,000,000), but higher than the scheduled drop to $25,000 for 2012.
On the business side, the following business tax breaks that expired at the end of 2009 have been retroactively reinstated and extended through 2011 by the Tax Relief Act:

The research and development credit.
15-year write-offs for qualified leasehold improvements, and restaurant buildings (and certain improvements to such restaurant buildings).
The employer wage credit for activated military reservists.
Expensing of environmental remediation costs.
The enhanced deduction for contributions of food and book inventories, and computer equipment for educational purposes.
A liberal rule for S corporations making charitable donations.
Empowerment zone tax incentives.
Renewal community tax incentives.
The work opportunity credit (extended for four months (through the end of 2011)).

Energy provisions

The following energy provisions were extended by the Act (through 2011):

The credit for manufacturers of energy-efficient new homes.
Incentives for biodiesel and renewable diesel.
Excise tax credits and outlay payments for alternative fuel and alternative fuel mixtures.
Grants for specified energy property in lieu of tax credits.
Provisions related to alcohol used as fuel.
The energy efficient appliance credit.
The credit for energy-efficient improvements to existing homes.
The 30% investment tax credit for alternative vehicle refueling property.

Estate & Gift Taxes

The new law brings back the estate tax, for 2011 and 2012 anyway, with a top rate of 35%. For 2011, the exemption amount will be $5 million per individual (indexed for inflation after 2011). (Tax historians would also note that except for the temporary repeal of the estate tax in 2010, the estate tax rate has not been less than 45% since 1931).

The new law also gives heirs of decedents dying in 2010 a choice of which estate-tax rules to apply - 2010's or 2011's. That's important because although there is no estate tax in 2010, some inherited assets are subject to higher capital gains tax under the 2010 rules, a situation that actually raises the tax burden for some heirs. Inherited assets under the 2010 rules have a tax basis equal to the price when they were purchased (referred to in tax parlance as "carryover basis") rather than the price at death. That could lead to a significant tax burden for heirs who sell assets such as stocks that had been held for many years and have greatly appreciated in value. Under the 2011 rules, by contrast, heirs will be allowed to inherit assets with a "stepped-up basis." While most heirs would choose the 2011 regime ($5 million exemption from both estate and generation-skipping tax and an unlimited step-up in the basis of assets to their current market value), the heirs of superrich decedents could find it more advantageous to elect the 2010 law (limited step-up in the basis of assets and no estate tax). If the executor makes the election to have the 2010 rules apply, the estate tax return's due date will not be earlier than the date that's nine months after the new law's enactment date.

Gifts

For gifts made after December 31, 2010, the gift tax will be reunified with the estate tax. Under the new law, the estate and gift tax exemptions will be reunified starting in 2011, which means that the $5 million estate tax exemption will also be available for gifts. The law in effect prior to 2010 provided a $3.5 million lifetime exemption for estates, but only $1 million for gifts. The gift tax rate, starting in 2011, will be 35%. The exemption from the generation-skipping tax (GST) - the additional tax on gifts and bequests to grandchildren when their parents are still alive - will also rise to $5 million from the $1 million it would have been without the new law. The GST tax rate for transfers made in 2011 and 2012 will be 35%.

From a planning standpoint, a nice feature of the new law is that it makes it easier to transfer the $5 million exemption to a surviving spouse, so married couples can shield $10 million of their assets from taxes. In the language of tax professionals, the estate tax exemption will be "portable."

If you would like more details about these provisions or any other aspect of the new law, please do not hesitate to call.

HAPPY NEW YEAR!

The Staff at Houlihan, LLP