The Tax Relief Act of 2010: Income Tax Provisions
Congress has passed a comprehensive set of income tax, estate tax, and unemployment insurance provisions as outlined by the deal previously negotiated between President Obama and Republican legislators. H.R. 4853, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, was approved by the Senate by a vote of 81 in favor to 19 against on December 15th, 2010; the House approved the measure on December 16th by a vote of 277 in favor to 148 against; and President Obama signed H.R. 4853 into law on December 17.
The final version of the legislation mirrors the previously announced framework agreed to by the President and Republication leaders. H.R. 4853 keeps intact for two more years America's existing tax rate structure, temporarily fixes the AMT, and extends a number of deductions and tax credits, provides a temporary one-year reduction in Social Security taxes, temporarily reforms estate and gift taxes, and provides a number of incentives for businesses to invest in equipment.
Temporary is the key theme running throughout the 2010 Tax Relief Act. Most of its provisions are temporary, two year fixes that impact 2011 and 2012 only. All of the Bush-era tax cuts that were scheduled to expire at the end of 2010 will now expire at the end of 2012. From a tax planning perspective, this gives taxpayers and their accountants an additional two years of certainty for constructing tax strategies. But 2012 is an election year, and a presidential election year at that. Future Congresses and the next president will need to address America's tax system comprehensively since all of the tax breaks implemented under the Bush and Obama administrations will expire at the end of 2012.
Now for all the details....
Personal tax rates for the years 2011 and 2012 will keep our existing six-rate structure ranging from 10% to 35%. If the Tax Relief Act had not passed, the tax rates would have revert to their pre-2001 levels ranging from 15% to 39.6%. The IRS has not yet released the official 2011 tax rates.
Capital gains tax rateswill remain the same, with a zero percent and a 15% rate applied to long-term gains and a 15% rate applied to qualifying dividends. If the Tax Relief Act had not passed, the 0% rate would have risen to 10%; the 15% rate would have risen to 20%; and dividends would have been taxed at ordinary rates instead of the preferred 15% rate.
Social Security tax rates will be reduced by two percentage points. The employee-portion of Social Security taxes will be reduced from the current 6.2% to a temporary rate of 4.2% for 2011 only. The employer-portion remains the same at 6.2%; and the Social Security wage base remains the same at $106,800 for 2011. Medicare tax rates are not changed: remaining at 1.45% each for employees and employers. Freelancers, farmers and other self-employed persons will see a corresponding reduction in their self-employment tax. The total 15.3% self-employment tax rate is temporarily reduced for 2011 to 13.3%. Self-employed persons will still be able to deduct the full amount of the employer's portion as an adjustment to income. Congress has directed the Treasury to reimburse the Social Security trust fund for the full amount of the reduced Social Security taxes out of the general fund.
Alternative minimum tax exemptions have been temporarily increased for the years 2010 and 2011 (but not for 2012). Exemption amounts help prevent some middle income earners from being subject to the AMT, and helps keep any AMT adjustments less than they otherwise might have been.
The American Opportunity Credit is extended through the end of 2012. This credit, introduced under Obama's administration, provides a refundable tax credit up to $2,500 based on expenses for the first four-years of undergraduate education. The American Opportunity credit was scheduled to expire at the end of 2010.
The enhanced Child Tax Credit is extended through the end of 2012, providing up to a $1,000 in partially refundable tax credits for children under the age of 17. The credit was scheduled to revert back to its previous maximum of $500.
The enhanced Earned Income Credit is extended through the end of 2012. The EIC was scheduled to revert back to prior law in which the EIC maxed out at two dependents. The higher EIC amounts for a third dependent will remain in effect for two more years.
The Adoption Tax Credit with its higher dollar amounts has been extended through the end of 2012. The credit was scheduled to revert back to a $5,000 limit in 2012; the Tax Relief Act extends the higher dollar limits by one additional year. However, the Tax Relief Act does not extend the refundable treatment of the adoption credit; thus 2011 will be the last year of the refundable adoption credit.
The Dependent and Child Care Tax Credit: this credit was scheduled to falls back to its previous maximums of $2,400 for one child and $4,800 for two or more children. The Tax Relief Act extends until 2012 the higher maximums of $3,000 for one child and $6,000 for two or more children.
Temporary repeal of the dollar limitation on itemized deductions. Previously enacted as a one-year only repeal in 2010, the Tax Relief Act suspends for two additional years (until the end of 2012) the limitation on itemized deductions for higher-income earners.
Temporary repeal of the Personal Exemption phaseout. Similarly, the temporary one-year repeal of the phaseout for personal exemptions is extended for two additional years.
Deduction for Student Loan Interest is extended for two more years. After 2012, the deduction will revert to a previous tax law in which interest on a student loan is deductible only for the first 60-months of repayment.
Sales Tax Deduction is retroactively re-instated for 2010 and extended through 2011. This is an optional itemized deduction in lieu of the deduction for state income taxes. Note: this deduction now expires in 2011.
Tuition and Fees Deduction is retroactively re-instated for 2010 and extended through 2011. This particular deduction can sometimes be more useful than the American Opportunity or the Lifetime Learning tax credits. Note: this deduction now expires in 2011.
Classroom Expense Deduction for teachers extends for two years (2010 and 2011).
Charitable contributions of IRAs. Individuals age 70.5 years old or older may donate up to $100,000 of their individual retirement account directly to a qualified charity in a trustee-to-trustee transfer. The charitable gift bypasses reporting on the tax return (no IRA income is reported and no charity deduction is reported), which can keep a charitable person's adjusted gross income lower and thereby avoids any adjustments in Medicare premiums. Extended for two years: 2010 and 2011.
Business Tax Breaks
Jean Murray, About.com's Guide to Business Law and Taxes, summarizes the business-related tax provisions of the 2010 Tax Relief Act.
Estate Tax Provisions
Julie Garber, About.com's Guide to Wills and Estate Planning, summarizes the estate tax provisions of the 2010 Tax Relief Act.
Additional resources:
The final version of the legislation mirrors the previously announced framework agreed to by the President and Republication leaders. H.R. 4853 keeps intact for two more years America's existing tax rate structure, temporarily fixes the AMT, and extends a number of deductions and tax credits, provides a temporary one-year reduction in Social Security taxes, temporarily reforms estate and gift taxes, and provides a number of incentives for businesses to invest in equipment.
Temporary is the key theme running throughout the 2010 Tax Relief Act. Most of its provisions are temporary, two year fixes that impact 2011 and 2012 only. All of the Bush-era tax cuts that were scheduled to expire at the end of 2010 will now expire at the end of 2012. From a tax planning perspective, this gives taxpayers and their accountants an additional two years of certainty for constructing tax strategies. But 2012 is an election year, and a presidential election year at that. Future Congresses and the next president will need to address America's tax system comprehensively since all of the tax breaks implemented under the Bush and Obama administrations will expire at the end of 2012.
Now for all the details....
Personal Tax Rates
Personal tax rates for the years 2011 and 2012 will keep our existing six-rate structure ranging from 10% to 35%. If the Tax Relief Act had not passed, the tax rates would have revert to their pre-2001 levels ranging from 15% to 39.6%. The IRS has not yet released the official 2011 tax rates.
Capital gains tax rateswill remain the same, with a zero percent and a 15% rate applied to long-term gains and a 15% rate applied to qualifying dividends. If the Tax Relief Act had not passed, the 0% rate would have risen to 10%; the 15% rate would have risen to 20%; and dividends would have been taxed at ordinary rates instead of the preferred 15% rate.
Social Security tax rates will be reduced by two percentage points. The employee-portion of Social Security taxes will be reduced from the current 6.2% to a temporary rate of 4.2% for 2011 only. The employer-portion remains the same at 6.2%; and the Social Security wage base remains the same at $106,800 for 2011. Medicare tax rates are not changed: remaining at 1.45% each for employees and employers. Freelancers, farmers and other self-employed persons will see a corresponding reduction in their self-employment tax. The total 15.3% self-employment tax rate is temporarily reduced for 2011 to 13.3%. Self-employed persons will still be able to deduct the full amount of the employer's portion as an adjustment to income. Congress has directed the Treasury to reimburse the Social Security trust fund for the full amount of the reduced Social Security taxes out of the general fund.
Alternative minimum tax exemptions have been temporarily increased for the years 2010 and 2011 (but not for 2012). Exemption amounts help prevent some middle income earners from being subject to the AMT, and helps keep any AMT adjustments less than they otherwise might have been.
Personal Tax Credits
The American Opportunity Credit is extended through the end of 2012. This credit, introduced under Obama's administration, provides a refundable tax credit up to $2,500 based on expenses for the first four-years of undergraduate education. The American Opportunity credit was scheduled to expire at the end of 2010.
The enhanced Child Tax Credit is extended through the end of 2012, providing up to a $1,000 in partially refundable tax credits for children under the age of 17. The credit was scheduled to revert back to its previous maximum of $500.
The enhanced Earned Income Credit is extended through the end of 2012. The EIC was scheduled to revert back to prior law in which the EIC maxed out at two dependents. The higher EIC amounts for a third dependent will remain in effect for two more years.
The Adoption Tax Credit with its higher dollar amounts has been extended through the end of 2012. The credit was scheduled to revert back to a $5,000 limit in 2012; the Tax Relief Act extends the higher dollar limits by one additional year. However, the Tax Relief Act does not extend the refundable treatment of the adoption credit; thus 2011 will be the last year of the refundable adoption credit.
The Dependent and Child Care Tax Credit: this credit was scheduled to falls back to its previous maximums of $2,400 for one child and $4,800 for two or more children. The Tax Relief Act extends until 2012 the higher maximums of $3,000 for one child and $6,000 for two or more children.
Personal Tax Deductions
Temporary repeal of the dollar limitation on itemized deductions. Previously enacted as a one-year only repeal in 2010, the Tax Relief Act suspends for two additional years (until the end of 2012) the limitation on itemized deductions for higher-income earners.
Temporary repeal of the Personal Exemption phaseout. Similarly, the temporary one-year repeal of the phaseout for personal exemptions is extended for two additional years.
Deduction for Student Loan Interest is extended for two more years. After 2012, the deduction will revert to a previous tax law in which interest on a student loan is deductible only for the first 60-months of repayment.
Sales Tax Deduction is retroactively re-instated for 2010 and extended through 2011. This is an optional itemized deduction in lieu of the deduction for state income taxes. Note: this deduction now expires in 2011.
Tuition and Fees Deduction is retroactively re-instated for 2010 and extended through 2011. This particular deduction can sometimes be more useful than the American Opportunity or the Lifetime Learning tax credits. Note: this deduction now expires in 2011.
Classroom Expense Deduction for teachers extends for two years (2010 and 2011).
Charitable contributions of IRAs. Individuals age 70.5 years old or older may donate up to $100,000 of their individual retirement account directly to a qualified charity in a trustee-to-trustee transfer. The charitable gift bypasses reporting on the tax return (no IRA income is reported and no charity deduction is reported), which can keep a charitable person's adjusted gross income lower and thereby avoids any adjustments in Medicare premiums. Extended for two years: 2010 and 2011.
Business Tax Breaks
Jean Murray, About.com's Guide to Business Law and Taxes, summarizes the business-related tax provisions of the 2010 Tax Relief Act.
Estate Tax Provisions
Julie Garber, About.com's Guide to Wills and Estate Planning, summarizes the estate tax provisions of the 2010 Tax Relief Act.
Additional resources:
- CCH Tax Briefing on the Tax Relief Act (pdf, 11 pages)
- Tax Cut Extension Enacted (Journal of Accountancy)
- Technical Explanation of the Tax Relief Act (Joint Committee on Taxation)