Tax legislation clears way for planning opportunities

January 14, 2011
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The tone of the recent holiday season seems to have been more upbeat than in recent years. My kids had the iPod-nano at the top of their wish list. For others, it may have been a tax cut (or to be more precise, the avoidance of a tax rate increase in 2011). In the end, I think my kids and many taxpayers felt they got what they wished for.

The year-end lame duck Congressional session did get some things done. Despite some of the terse political rhetoric, a tax legislative compromise was put together and the resulting legislation enacted into law. The fog of tax uncertainty gave way to some clarity, at least for perhaps the next 24 months. Nearly all taxpayers were able to have a gift placed in their stocking.

With the good news came some not-so-good news. The IRS has announced delays for processing of tax returns for the 2010 filing season as it needs to update its software to accommodate and adjust for the late changes in the tax code. The consumer tax software providers also are in a hold pattern as they will need to adjust to the changes the IRS requires in forms and electronic filing formats. Thus, for many taxpayers, it means a delay if one was planning to be an early filer.

The timing of the late December tax legislation was undoubtedly good news for most taxpayers. For starters, the payroll tax reduction that was effective Jan. 1, 2011, for Social Security taxes (a 2 percent payroll tax rate reduction) is a significant benefit for all wage earners. A wage earner that earns $75,000 a year will receive a $1,500 reduction in the payroll tax in 2011. This payroll tax benefit, coupled with the benefits under the extension of the Bush tax cuts, provides a double benefit for nearly all taxpayers.

The Bush tax cuts were scheduled to expire at the end of 2010, and nearly every taxpayer was scheduled to see a tax increase for 2011 if no action was taken. That political reality likely explains why a deal was cut prior to the end of 2010.

The benefits were not limited to individual taxpayers. Many businesses that expect to have capital expenditures for equipment and machinery also received something in their stockings. Additional first-year depreciation on qualified property was extended through 2012. For qualified property acquired and placed into service after Sept. 8, 2010, and before Jan. 1, 2012, a 100 percent deduction is allowed. For qualified property placed into service in 2012, a 50 percent deduction in the first year is permitted. Of course, a deduction upfront will reduce any tax depreciation expense for the years following the year of the expenditure.

Business taxpayers also can elect to use minimum tax credits resulting from prior AMT liabilities in 2011 and 2012 if the taxpayer agrees to forgo the use of bonus depreciation on qualified property in 2011 and 2012 and depreciate the acquired property on a straight-line basis. The credit (which is refundable) is limited to 6 percent of the amount of the credits that have been generated before 2008 and have not been used in years ending before April 1, 2008. There are other limitations for the amount of the credit that can actually be claimed by a taxpayer.

The research credit was renewed for two additional years (2010 and 2011). That was a welcome and somewhat expected extension, though nearly all of 2010 passed by before it was made effective back to the start of the 2010 year. The credit is essentially a wage-based credit based on increasing the level of activity on research-related activities within a business.

Many employment-based credits were extended as were other tax credits, including the child credit, the adoption credit and certain education credits. Most of these were expected to be renewed, but the risk of Washington deal-making provides some suspense until the final act is signed into law.

The top long-term capital gains tax rate remains at 15 percent for the next two years. The top rate of tax on qualified dividends also remains at the 15 percent rate for 2011 and 2012. There has been some discussion on whether unearned income should be taxed at lower tax rates and whether it encourages investment and capital formation which increases U.S. business activity and job growth.

The alternative minimum tax or AMT patch also was extended for 2010 and 2011. In addition, nonrefundable personal credits are allowed to reduce an individual’s AMT liability in 2010 and 2012.The AMT patch adjusts the AMT exemption amount  for a married couple from $45,000 (without the patch) to $72,450 in 2010 and $74,450 in 2011.

The AMT was enacted in 1969 to catch the 200 or so millionaires who were paying no income tax. Currently, the AMT, even with the patch, catches millions of middle-class and upper-middle-class taxpayers as a result of changes made in 1986. The biggest driver is the adjustment for itemized deductions of state and local income and property taxes. The long-term issue of so many middle-class taxpayers falling into the clutches of the AMT has not been addressed in the recent legislation.

Retroactive tax planning is rarely permitted. There may an exception for January 2011. A provision that can be used in January 2011 for the 2010 tax year is the extension of the tax-free distributions from individual retirement plans for charitable purposes. The provision was extended for 2010 and 2011 for certain distributions from IRAs up to $100,000 per taxpayer, per year. There are some very specific requirements in order to qualify for the favorable treatment, and taxpayers should consult their professional advisers before deciding whether to take advantage of this provision.

The legislation included one compromise that may benefit many families that have small and medium businesses as an asset of their estates. The estate tax was reinstated. For 2010, there is an election available to use carryover basis and elect no estate tax for deaths occurring in 2010. For decedents dying in 2011 and 2012, the estate tax exemption is increased to $5 million. Also for 2011 and 2012, the gift tax exemption was equalized with the estate tax exemption (at $5 million). The maximum estate tax rate in 2011 and 2012 is set at 35 percent. The estate tax provisions are in effect for 2011 and 2012 and may allow for planning opportunities for those with larger estates to take advantage of the changes.

There is much speculation in Washington that the coming two years will likely require tough spending decisions coupled with some type of tax code reform or overhaul. The political landscape and the 2012 elections may influence what actually happens. The recent tax legislation may allow for planning opportunities over the next year or two for many taxpayers before the fog of uncertainty begins to roll in all over again.

William F. Roth III is a tax partner with BDO USA LLP. The views expressed above are those of the author and are not necessarily those of BDO. The comments expressed are not to be considered as specific advice and cannot be relied upon for the purposes of avoiding penalties. Readers are advised to consult with their professional advisers before acting on items discussed.

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