The Tax Relief Act Of 2010

Mapping Out Strategies for Individuals

The main message you heard when the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was passed in December may have been that “taxes won’t go up now after all.” But, there’s more to it than that. The act’s many provisions, in fact, map out the tax planning terrain for the near future.

Your rates and paycheck

Indeed, individual income tax rates won’t go up this year because the Tax Relief act extends the so-called “Bush tax cuts” for two years (through Dec. 31, 2012). That’s good news because rates now ranging from 10% to 35% had been scheduled to return this year to previous levels ranging from 15% to 39.6%.

If you’re concerned about your alternative minimum tax (AMT) liability, the Tax Relief act offers relief here as well. It increases AMT exemptions that would otherwise have decreased substantially for the 2010 and 2011 tax years, lessening the odds that you’ll be subject to the tax.

What’s more, for 2011, you’ll pay less of your share (as an employee) of Social Security taxes. Rates on earnings up to the taxable wage base ($106,800 in 2011) were dropped from 6.2% to 4.2%. That means if you earn $100,000 in 2011, you’ll save $2,000 in payroll taxes over what you would have paid under the previous rate.

How should all of this affect your tax planning? The extension of the lower individual tax rates along with the payroll tax cuts should keep your tax bill at least a little lower for the next couple of years. Start thinking now of ways to put these freed-up dollars to good use, whether paying down debt or starting (or increasing) your savings.

Additionally, for 2011 you can employ the traditional tax planning strategy of deferring income to the next year and accelerating deductible expenses into the current year (unless you expect to be in a higher bracket next year or are concerned about the AMT). This will defer tax to 2012. In 2012, however, you may want to avoid such a strategy. If tax rates do go up in 2013 as scheduled, deferring income to that year could be costly.

Your investments

If you’re an investor, 2010 may have had an ominous feel to it, as the 15% tax rate on long-term capital gains and qualified dividends (generally 0% for those in the 10% and 15% brackets) was set to expire at year end.

Again, the Tax Relief act truly brought some relieving news in that these rates have been extended through Dec. 31, 2012. Absent this extension, the capital gains rate would have gone up to 20% (10% for those in the 15% bracket) and qualified dividends would have reverted to being subject to ordinary-income rates as high as 39.6%.

In light of these developments, take another look at your portfolio. If you were in a hurry to sell off some appreciated investments to avoid paying tax at the 20% rate, you’ve been granted a temporary reprieve.

In fact, rather than sell the shares, you may want to gift them. If you give long-term appreciated assets to your children or other family members who are in the 10% or 15% income tax bracket (and they’re not subject to the “kiddie tax”), they can take advantage of the 0% rate on some or all of the gain.

Thus, you’ll minimize — and perhaps eliminate — the tax that you, as a family, will pay. This strategy may be appropriate if you initially intended to make a gift using the cash from the sale. (Keep in mind the gift tax, however. See the sidebar “Don’t neglect your estate plan.”)

Your circumstances and needs

The Tax Relief act is a provision-rich bill, and assessing its details may reveal a variety of tax-planning strategies that fit your specific circumstances and needs. For example, many tax breaks for parents have been extended through 2012, including:

• The enhanced child credit,
• The enhanced dependent care credit,
• The enhanced adoption credit and adoption assistance exclusion, and
• The American Opportunity credit (for higher education expenses).

If you live in a state with no or low state income taxes or you’re considering a major purchase, such as a car or boat, you’ll want to be aware that the ability to take an itemized deduction for state and local sales taxes in lieu of state and local income taxes has been extended through 2011 (but not for 2012). If you’re considering a major purchase, you may want to make it this year to ensure you can deduct the sales tax.

The point is, any major life circumstance or change that’s on the near horizon could remain a little more tax-friendly for a while longer. So it’s wise to sit down and review your plans in the short term to see whether any of the extended tax breaks of this law could benefit you and whether there are any steps you should take to lock in potential savings.

Your move

On its face, the Tax Relief act didn’t change things so much as keep them the same for a little bit longer. But that doesn’t mean you should do nothing. Rather, by opening this window for further tax savings under the current rates, Uncle Sam is essentially saying, “Your move.”

Don’t neglect your estate plan

It’s been all too easy to neglect estate planning recently because of the great uncertainty surrounding whether an estate tax would even exist for 2010. But the passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 means no one should neglect his or her estate plan any longer.

The act reinstates the estate tax for 2010 at a top rate of 35% (down from 2009’s 45%) and a $5 million exemption (up from 2009’s $3.5 million), and with a generally unlimited step-up in basis. The top estate and gift tax rates and the generation-skipping transfer (GST) tax rate are set at 35% for 2011 and 2012.

Meanwhile, the estate, gift and GST tax exemptions are $5 million for 2011 and indexed for inflation in 2012. The act also allows “portability” of the estate tax exemption between spouses for 2011 and 2012. But these provisions will sunset on Dec. 31, 2012, which would mean dramatic rate increases and exemption reductions. You’ll need to consider the changing rates and exemptions in setting up and maintaining your estate plan.

If you’re managing the estate of a loved one who died in 2010, note that you may either calculate estate taxes using the new 35% top rate and $5 million exemption (with a stepped-up basis for all estate assets) or elect to apply the law as it existed before the act — that is, no estate tax but a modified carryover basis regime.

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