Recent Tax Law Changes: The Good, The Bad & The Ugly LeighAnn Costley January 28, 2011

Recent Tax Law Changes:The Good, The Bad & The Ugly

LeighAnn Costley

January 28, 2011

2010 Major Tax Legislation

• Patient Protection & Affordable Health Care Act and Health Care & Education Reconciliation Act (together the “2010 Health Care Reform Act”)

• Signed by President Obama within days of each other– Patient Protection & Affordable Care Act – March 23, 2010

– Health Care & Education Reconciliation Act – March 30, 2010

• Small Business Jobs Act of 2010 (“2010 Small Business Act”)

• Signed by President Obama on September 27, 2010

• Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“2010 Tax Relief Act”)

• Signed by President Obama on December 17, 2010

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2010 Health Care Reform Act

• Medicare tax hike on earned income – beginning in 2013• Earned income > $200,000 for individuals or > $250,000 for married taxpayers filing

joint returns

• 0.9% additional tax for amounts above thresholds

• Assessed only on employee/individual taxpayer, not employer

– Change from current law where payroll tax liabilities are 50/50

• Not deductible by self-employed individuals

• Employer is required to withhold additional tax

– Not required to consider earned income for employee’s spouse

– May be subject to penalties as a result


• Medicare earned income surplus tax – example calculations• Assumes Social Security wage limitation of $106,800 (2010)

Employee Spouse Total Employee Spouse Total Employee Spouse Total Employee Spouse Joint

75,000 75,000 150,000 4,650 4,650 9,300 1,088 1,088 2,175 - - - 200,000 100,000 300,000 6,622 6,200 12,822 2,900 1,450 4,350 - - 450 300,000 200,000 500,000 6,622 6,622 13,243 4,350 2,900 7,250 900 - 2,250

1,000,000 500,000 1,500,000 6,622 6,622 13,243 14,500 7,250 21,750 7,200 2,700 11,250

Wages Social Security (6.2%) Medicare (1.45%) Additional Medicare (0.9%)


• Medicare tax on unearned income – beginning in 2013• Income from interest, dividends, capital gains, annuities, royalties and rents received

(from passive activities only), as well as net investment income from passive activities

• 3.8% additional tax for amounts above thresholds, applied against the lesser of net investment income or modified adjusted gross income in excess of the threshold amounts

• Modified adjusted gross income > $200,000 for individuals or > $250,000 for married taxpayers filing joint returns

• Assessed independently from the additional Medicare tax on earned income


• Medicare tax on unearned income – example calculations

Wages

Investment

Income Modified AGI Wages

Investment

Income Modified AGI

175,000 40,000 215,000 - 1,520 570 300,000 75,000 375,000 900 2,850 6,650

1,000,000 200,000 1,200,000 7,200 7,600 38,000

Wages

Investment

Income Modified AGI Wages

Investment

Income Modified AGI

175,000 40,000 215,000 - - - 300,000 75,000 375,000 450 2,850 4,750

1,000,000 200,000 1,200,000 6,750 7,600 36,100

Single Taxpayer Additional Medicare Tax

Joint Taxpayers Additional Medicare Tax


• Definition of “medical expense” for purposes of employer-provided health coverage (including FSAs, HRAs, HSAs & MSAs) modified to conform to the definition for purposes of itemized deductions beginning in 2011

• Eliminates nontaxable reimbursements of over-the-counter medications unless prescribed by a physician

• Penalty on non-qualified withdrawals from HSAs and MSAs increased to 20% (from 10% for HSAs, from 15% for MSAs) beginning in 2011

• FSA contributions limited to $2,500 beginning in 2013 – most employers routinely limit contributions to $5,000

• Threshold for itemized deductions for medical expenses increased to 10% of AGI beginning in 2013


• All individuals, generally, must obtain health insurance or be subject to federal tax penalties beginning in 2014

• Annual penalty for each individual, although penalty for minor dependents is ½ that of adults

• Individual penalty amount is the greater of

– $95 or 1% of income over the filing threshold (2014)

– $325 or 2% of income over the filing threshold (2015)

– $695 or 2.5% of income over the filing threshold (2016)

– Indexed for inflation for years thereafter

• Penalty applies pro rata on a monthly basis depending on whether “minimum essential coverage” was maintained for each month

• Certain hardship exceptions and caps to the penalty amount also apply

2010 Small Business Act

• Section 179 increases for 2010 and 2011

• Expensing limitation increased to $500,000 from $250,000

• Phase-out threshold raised to $2 million from $800,000– Prior law for 2011 was $25,000 expense limitation and $200,000 threshold

• Qualified real property expensing for 2010 and 2011

• Up to $250,000 of qualified real property eligible for section 179 treatment– Qualified leasehold improvement, restaurant and retail improvement property (as

defined by section 179(f)(2))

– FIRST time that real property has been eligible for section 179 expensing; previously limited to tangible personal property

– No carryover to tax years beyond 2011 of unused amounts attributable to qualified real property

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• Computer software as qualifying property for section 179 purposes is extended through 2011

• 50% bonus depreciation is available for qualifying property acquired and placed in service in 2010

• First year depreciation deduction for automobiles and light trucks has been increased by $8,000 (to $11,060 and $11,160, respectively) for qualifying property acquired and placed in service in 2010

• Start-up expenses under section 195 for 2010 and 2011

• Deductible amount is increased to $10,000 from $5,000

• Phase-out threshold is increased to $60,000 from $50,000

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• General Business Credits (“GBC”)

• Generally cannot exceed the excess of taxpayer’s net income over– Tentative minimum tax, OR

– 25% of net regular tax liability that exceeds $25,000

• Certain credits generated in 2010 in excess of this limitation can be carried back 5 years (as opposed to 1 year)

• Applies only to eligible small businesses (“ESB”)– Non-public corporations, partnerships or sole proprietorships, AND

– Average annual gross receipts for three year period preceding the tax year of less than $50 million (must be met both at the entity and owner level for pass-throughs)

• ESBs can offset AMT liability with GBCs generated in 2010– All GBCs as defined in Section 38(c)(5)(B)

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• Holding period of assets subject to built in gains (“BIG”) tax is shortened to 5 years for 2011

• Holding period of 7 years for 2010

• Health insurance costs can be excluded from the calculation of self-employment tax for 2010

• Gain from the sale of qualified small business stock (defined under section 1202) is excluded if

• Original issue acquisition after September 27, 2010 and before January 1, 2011 and held for at least 5 years

• Gain exclusion is limited to the greater of $10 million (MFJ) or twice basis, whichever is greater

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• Revenue raisers to offset tax breaks

• Rental property owners must provide form 1099s for all service providers to whom they paid more than $600 for rental property expenses beginning in 2011

• Distributions from 401(k), 403(b) and governmental 457(b) plans can be rolled over to a Roth IRA account after September 27, 2010 (applies to pre-tax contributions only)

• Estimated tax payments for large corporations (assets > $1 billion) due in July, August or September 2015 are increased by 36%

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Brief History Lesson

• Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)

• De-coupled the lifetime exemption for estate & gift purposes

• Repealed the estate tax for 2010

• Provided reduced marginal income tax rates for individuals and marriage penalty relief

• Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA)

• Provided reduced capital gains tax rate

• Created the reduced income tax rate for qualified dividends

• “Sunset” rule provided that all these provisions would expire as of December 31, 2010

2010 Tax Relief Act – Estate & Gift

• Lifetime exemption increased to $5 million from $1 million (per person)

• “Re-unifies” the exemption for estate and gift purposes

• Top estate tax rate reduced from 55% to 35%

• Gift tax rate remains 35%

• Basis step-up

• Deceased spousal unused exclusion amount (portability feature)

• Lesser of $5 million or the unused exemption of the last deceased spouse

• Election must be made on a timely filed estate return, regardless of whether a return would otherwise be filed

• Applicable to lifetime exemption, so can be used for gifting purposes by the surviving spouse

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• Portability Example

• Husband 1 dies in 2011, having made taxable transfers of $3 million and having no taxable estate. Election is made on the 706 to permit Wife to use his deceased spousal unused exclusion amount. At his DOD, Wife has made no taxable gifts. Thereafter, Wife’s applicable exclusion amount is $7 million.

• Wife marries Husband 2, who predeceases Wife. Husband 2 had made $4 million of taxable transfers and leaves no taxable estate. Election is made on 706 to permit Wife to used his deceased spousal unused exclusion amount. Thereafter Wife’s applicable exclusion amount is reduced to $6 million.


• For 2010 decedents, the provisions of the 2010 Tax Relief Act apply unless the executor elects to have the EGTRRA rules apply

• Zero tax and modified carry over basis

• Extension of time to file an estate return and pay any applicable estate taxes for any decedent who died after December 31, 2009 and before December 17, 2010 until September 17, 2011

• Not a permanent fix…just an extension of the “sunset”

• After December 31, 2012, $1 million exemption and 55% top rate are again in effect

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• GST Exemption

• Equals the applicable estate exclusion for 2010 ($5 million)

• Equals the basic exclusion for 2011 and 2012

• GST transfer tax rate

• For 2010 is 0%

• For 2011 and 2012 is 35%

• Prior gift tax calculation is simplified

• Estate tax rates in effect at DOD are used to compute both – the gift tax imposed on prior gifts and

– the unified credit allowed against such gifts

2010 Tax Relief Act - Individuals

• Extends reduced individual tax rates

• Six brackets – 10%, 15%, 25%, 28%, 33% and 35%

• Would have been five brackets – 15%, 28%, 31%, 36% and 39.6%

• Reinstates “marriage penalty” relief

• MFJ is 200% of the Single bracket for those filers in the 15% rate

• Standard deduction for MFJ is twice that of Single filers

• Both were scheduled to be 167% of the Single amount

• Extends the non-applicability of the Pease limitation on itemized deductions for higher-income taxpayers

• Extends the suspension of the phase-out of personal exemptions for higher-income taxpayers

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• Extends the reduced capital gains and qualified dividend rates for 2011 and 2012

• 15% for those taxpayers in the top four brackets

• 0% for those taxpayers in the 10% and 15% brackets

• Capital gains rate was scheduled to be 20%

• Qualified dividend rate was scheduled to be the taxpayer’s marginal rate

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• Extends a wide array of child-related benefits through 2012

• Child tax credit– $1,000 credit for each qualifying child under age 17 claimed as a dependent

– Phased out for modified AGI in excess of $110,000 (MFJ) and $75,000 (Single)

– Can offset both regular tax and AMT

– Refundable to the extent of the greater of– 15% of earned income over $3,000 OR– Excess of social security taxes over the earned income credit (if 3 or more qualifying

children)

– Credit was scheduled to be reduced to $500, only be allowed against regular tax, and the refundability was more restrictive

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• Child related benefits (continued)

• Dependent care credit– 35% of up to $3,000 of eligible expenses for one qualifying child; up to $6,000 for

two or more qualifying children

– Credit percentage reduced to 20% of qualifying expenses if AGI exceeds $43,000

– Was scheduled to be reduced to 30% of eligible expenses ($2,400 for one child and $4,800 for two or more)


• Child related benefits (continued)

• Earned income tax credit– Simplified definition of earned income and qualifying child

– Elimination of the reduction of EITC for taxpayers subject to AMT

– Phase-out applies based on AGI rather than modified AGI

– Increased rate (45%) and higher threshold for MFJ taxpayers

– All of these provisions were scheduled to be repealed

• Adoption credit and employer-provided adoption assistance exclusion– $13,170 for 2010 ($13,360 for 2011) per eligible child; adjusted annually for inflation

– Phased out for modified AGI greater than $182,520 in 2010 ($185,210 for 2011)

– Credit is refundable for 2010 and 2011 under Patient Protection and Affordable Health Care Act

– Were scheduled to be applicable to special needs adoptions only, for a maximum amount of $6,000, and phased out at modified AGI of $75,000

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• Extends a number of educational benefits through 2012

• American opportunity tax credit– Credit of up to $2,500 ($2,000 + 25% of next $2,000) of qualified higher education

tuition and related expenses

– Phased out beginning with modified AGI of $160,000 (MFJ) or $80,000 (Single)

– Offsets both regular tax and AMT liabilities

– Partially refundable (up to 40% of allowable credit)

– Was not scheduled to exist beyond 2010; instead Hope credit of up to $1,8000 would have been available

• Employer provided educational assistance– Up to $5,250 excludable under a qualified program

– Does not have to be job related

– Was scheduled to be excludable only if qualified as a working condition fringe benefit

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• Educational benefits (continued)

• Student loan interest above-the-line deduction– Up to $2,500 on qualified higher education loans

– Phased out for taxpayers with modified AGI of $120,000 (MFJ) and $60,000 (Single)

– Was scheduled to be phased out at $60,000 (MFJ) and $40,000 (Single) – inflation adjusted since 2002 – and only deductible for first 60 months of loan repayment period

• Coverdale educations savings accounts– Up to $2,000 contributed for beneficiaries under age 18

– Phased out for taxpayers with modified AGI of $190,000 (MFJ) and $95,000 (Single)

– Was scheduled to be a contribution limit of $500 and phased out at $150,000 (MFJ)

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• Provides the AMT “patch” for two years

• Exemption is $72,450 for MFJ and $47,450 for Single filers in 2010

• Exemption is $74,450 for MFJ and $48,450 for Single filers in 2011

• No patch for 2012

• Was scheduled to be $45,000 for MFJ and $33,750 for Single filers

• Allows certain non-refundable credits to offset AMT for 2010 and 2011

• Dependent care credit

• Credit for the elderly and disabled

• Credit for interest on certain home mortgages

• Hope scholarship and Lifetime Learning credits

• Credit for certain non-business energy property

• D.C. first-time homebuyer credit

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• Retroactively reinstates and extends many deductions through 2011

• Educator expenses (elementary and secondary school teachers)– Up to $250 paid for books, certain supplies, computers & other equipment, and

supplementary materials used in the classroom

– Was not scheduled to be available for years after 2009

• Qualified tuition and related expenses– Above the line deduction for qualified tuition and related expenses

– Was not scheduled to be available for years after 2009

• State and local sales taxes (in lieu of state and local income taxes)– Was not scheduled to be available for years after 2009

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• Deductions (continued)

• Contributions of qualified conservation easements– Appreciated real property

– 50% of AGI and 15 year carryover

– Was scheduled to revert to normal rules for capital gain property for years after 2009

• Tax-free distributions from IRAs to charities– Up to $100,000

– Taxpayers over age 70 ½; used to satisfy required minimum distribution

– Not included in gross income nor claimed as charitable deduction

– Can elect to have January 2011 distribution treated as made on 12/31/10

– Was not scheduled to apply for years after 2009

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2010 Tax Relief Act - Businesses

• Retroactively extends several benefits through 2011

• Research and development tax credit– 20% of the excess of qualified research expenses over a base amount, unless the

alternative simplified method is elected

– Was scheduled to expire after 2009

• New markets tax credit– Total credit of 39% over seven years (5% in years 1-3, 6% in years 4-7) for qualified

equity investments in community development entities

– $3.5 billion cap on maximum annual amount of qualifying equity investments

– Carryover allowed, but not beyond 2016

– Prior law provided a cap of $5 billion and carryover expiration in 2014

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• Benefit extensions (continued)

• 15 year depreciable life for qualified leasehold improvements, qualified restaurant property and qualified retail improvement property

– Was scheduled to revert to 39 year depreciable life for years after 2009

• Enhanced corporate contributions equal to the lesser of basis plus half of the property’s appreciation or twice the property’s basis for:

– Food inventory

– Book inventory to public schools

– Computer equipment to schools and libraries for educational purposes

• Election to expense film and television production costs– Up to $15 million for qualifying productions, or

– Up to $20 million if significantly incurred in certain low-income communities

– Was scheduled to expire after 2009 tax year

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• Benefit extensions (continued)

• Election to expense qualified environmental remediation costs– Paid or incurred in connection with the abatement or control of hazardous

substances at a qualified contaminated site

– Was scheduled to expire for years after 2009

• Charitable contributions of appreciated property by an S corporation– Shareholder reduces their basis by their pro rata share of the adjusted basis of the

property contributed

– Was scheduled to revert to prior law (FMV) for years after 2009

• Empowerment zone designation and incentives– 20% wage credit

– Liberalized section 179 expensing rules

– Deferral of capital gain on the sale of qualified assets subsequently replaced

– Was scheduled to expire for years after 2009

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2010 Tax Relief Act

• Economic Stimulus Incentives

• Unprecedented 100% first year deduction for the cost of qualified property placed in service after 9/8/10 and before 1/1/12

– Does not effect section 179 expense deduction

• Extends 50% bonus depreciation for property placed in service in 2012

• First year depreciation deduction for automobiles and light trucks has been increased by $8,000 (to $11,060 and $11,160, respectively) for qualifying property acquired and placed in service in 2011 and 2012

– Small Business Act extended this provision only through 2010

• Reduction in employee portion of FICA by 2% for both employed and self-employed persons

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Recent Tax Law Changes: The Good, The Bad & The Ugly LeighAnn Costley January 28, 2011