Timely Topics – January 21, 2011 |
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1. 2010 Tax Relief Act - Income Tax Rates and Payroll TaxesOn December 17, 2010, President Obama signed into law a two-year compromise for income, payroll, estate, gift, and generation skipping transfer (GST) taxes. The far-reaching tax legislation averted across-the-board income tax increases because Bush-era tax cuts enacted in 2001-2003 were due to expire at the end of 2010. However, the law provides only a two-year extension for all income tax brackets. Nonetheless, almost all individual taxpayers should come out ahead. As described below, the legislation also provided an additional unexpected tax break regarding payroll taxes. Affluent taxpayers benefit from the two-year repeal of the "Pease" limitation (named for the congressman who sponsored it) and personal exemption phase-out (PEP). These are deduction limits that functioned as back-door tax increases for many affluent taxpayers. The Pease provision cut itemized deductions by 3% for incomes above a threshold; PEP eroded the value of the personal exemption. For 2011 only, the law imposes a historic reduction in Social Security (FICA) taxes, cutting by two percentage points the employee's portion of the 6.2% tax. Savings per worker will vary with income, but could be as much as $2,136 for those earning more than $106,800, the maximum amount subject to Social Security tax. Both members of a married couple can receive the benefit. The legislation also contains a two-year patch for "alternative minimum tax" retroactive to January 2010. The AMT, an alternate tax regime originally meant to ensure that people with high incomes pay taxes, isn't indexed for inflation, and has come to include middle-class taxpayers. The patch spares an additional 21 million taxpayers this year. The law extends for two years the current tax rates on long-term capital gains and qualifying dividends. The top rate for both will remain at its historic low of 15%. The rate will remain zero for couples with taxable income below $69,000. Absent the extension, the top rate on long-term gains would have risen to 20%, while the top dividend rate could have risen to as high as 39.6%. Among the benefits extended through 2011: deductions for teacher expenses and for state sales taxes in lieu of state income taxes. Lawmakers also extended through 2011 the provision allowing taxpayers over age 70½ to make tax-free donations of IRA assets to qualified charities. 2. 2010 Tax Relief Act – Estate, Gift, and GST TaxesThe 2010 Tax Relief Act provided dramatic relief for those subject to estate taxes, but again, the relief is only for two years. Nonetheless, the two-year window provides a significant opportunity for wealth transfer at a reduced tax cost. In 2009, the highest gift, estate and "GST" tax rate was 45 percent. Estate tax is imposed on the value of all property owned by a decedent, wherever situated, in excess of the "estate tax exemption amount." In addition to estate or gift tax, GST tax is imposed on the value of all transfers to grandchildren (or individuals at least two generations younger) in excess of the "GST tax exemption amount." The estate and GST tax exemption amount in 2009 was $3.5 million per person ($7 million per couple) and the gift tax exemption amount was $1 million per person ($2 million per couple). In 2010, the estate tax was repealed for decedents dying during 2010. Prior to the passage of the 2010 Tax Relief Act, the law was set to revert, in 2011, to the onerous levels last seen in 2001 – a top gift, estate and GST tax rate of 55% with a $1 million exemption per person ($2 million per couple). Modifications to the estate and GST tax provisions generally are effective as of January 1, 2010. Modifications to the gift tax and other new rules generally are effective on January 1, 2011. The 2010-2013 situation is as follows:
* Executors of estates of decedents dying prior to December 17, 2010 have the option of electing into the pre-2010 Tax Relief Act law, which allows for no estate tax and a limited basis adjustment. ** Without further legislation, the law is scheduled to revert to 2001 levels on January 1, 2013. On January 1, 2011, for a period of two years, the gift tax is unified with the estate tax, with a 35% rate and $5 million exemption per person ($10 million exemption per couple). For the first time, the estate and gift tax exemption amounts will be "portable" between spouses. Surviving spouses may use the predeceased spouse's unused gift tax exemption amount to make additional lifetime gifts and estates of decedents dying after December 31, 2010 may apply the predeceased spouse's unused estate tax exemption amount. For example, assume the estate of a Husband and Wife is $5 million. Husband dies on January 1, 2011 and Husband's estate applies $2.5 million of his estate tax exemption against his $2.5 million community property estate, which passes to his Wife estate-tax free. At Wife's death, the estate has grown to $7 million. Wife's estate may apply her unused $5 million estate tax exemption as well as Husband's unused $2.5 million estate tax exemption, so Wife's estate will not incur estate tax. The same concept will apply for lifetime gifts by the surviving spouse. In summary, both estate and GST taxes were reinstated, as was expected, but rates and exemptions are both attractive relative to those in effect for 2009. In particular, the reinstated $5.0 million dollar estate tax exemption is considerably more than the 2009 $3.5 million dollar exemption, and marginal rates are 35% versus 45%. We understand that most (but not all) plans need not be modified at this time. Please call your estate attorney if you would like to discuss your existing plan with them in light of the foregoing. The annual gift-tax exclusion remains at $13,000. This means you can give as much as $13,000 this year ($26,000 for a couple) to anyone you wish, and to as many people as you want, without having to worry about taxes or even having to file any forms with the Internal Revenue Service. It's a simple way to help others and reduce the size of your taxable estate. You can give even more than that by paying directly for someone else's tuition or medical expenses. Just be sure to pay the institution directly. Finally, gifts to charitable organizations can be made in unlimited amounts without reducing the gift tax exemption. 3. 2010 IRA Contribution Deadline is 4/18/11Here's our annual reminder that IRA contributions should be of interest to all taxpayers who have earned income at least equal to the limits. Please note income from investments, Social Security, and pensions does not constitute earned income. The allowable contribution to an IRA attributable to 2010 is $5,000 for anyone under 50 years of age and $6,000 for those over 50 as of the last day of the calendar year. Accordingly, for a married couple the 2010 contribution limits total $10,000 - $12,000, depending on age. These single and married limits are high enough to make a considerable difference over time in the rate of after-tax wealth accumulation for all but the wealthiest U.S. taxpayers (i.e., not a big enough impact for the really wealthy). There are complicated rules limiting Roth IRA contributions and the deductibility (but not the allowability) of traditional IRA contributions. Nonetheless, even non-deductible contributions of $10,000-$12,000 to traditional IRA's repeated year after year can be valuable for enhanced wealth accumulation, especially for younger people, because of the long-term tax deferral respecting earnings attributable to the contributions. It is also important to note that a non-working spouse may qualify for a deductible IRA contribution depending on the other spouse's company-sponsored retirement plan participation status and the level of family income. Your tax preparer is usually the best source for guidance regarding IRA contributions as each individual case differs. In summary, the annual IRA contribution is almost always a good strategy. However, the contribution is a perishable commodity: once the deadline passes, you are out of luck for 2010. 4. IRA Conversion to a RothWith the start of 2010, all taxpayers, even wealthy ones, have the option of converting. This is a controversial and complicated topic. Many should not convert. However, if you are under 70½, not working or working at low pay, and are in a zero tax bracket due to low income and/or high deductions, conversion of some of a traditional IRA should definitely be considered. |
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