Individual Income Tax Provisions and Planning under the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010
EisnerAmper LLP continues coverage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“the Act”) signed into law by President Obama on December 17, 2010. Our initial Alert dated January 13, 2011, summarized and provided observations on key estate and gift tax provisions of the Act.
This Alert provides highlights and observations regarding individual income tax rates and certain credits and deductions.
The Economic Growth and Tax Relief Reconciliation Act of 2001, and the Jobs and Growth Tax Relief Reconciliation Act of 2003, reduced the top individual ordinary income tax rate to 35%, and the maximum long term capital gain and qualified dividends tax rate for individuals to 15%. These tax rates were scheduled to expire at December 31, 2010, but the Act extends these rates for two years beginning January 1, 2011. The Act also extends certain individual tax credits for the same two years through 2012 or, in the case of certain individual tax deductions, for the years 2010 and 2011.
Observation:Generally planning uncertainty exists for 2013 and future years and each taxpayer needs to examine carefully the proper timing for recognition of income, payment of deductions, and utilization of applicable tax credits.
1. Ordinary Income Tax Rates
Under prior law, the top ordinary individual income tax rate of 35% was scheduled to increase to 39.6% effective January 1, 2011, and it is currently unclear whether the retained 35% rate will be extended after 2012.
- Often multi-year total federal ordinary income tax, self-employment tax, and alternative minimum tax (“AMT”) can be minimized by accelerating or deferring income and deductions among tax years. For example, considering estimated taxable income for each of 2011 and 2012, measure the 2011 and 2012 total tax savings that may be attained by accelerating 2012 deductions to 2011 and deferring 2011 income to 2012, or deferring 2011 deductions to 2012 and accelerating 2012 income to 2011, and combinations thereof. With thoughtful planning, total multi-year regular taxes and AMT may be permanently minimized. This is also discussed in the section below on AMT.
- Accelerating to 2012 first-year required minimum distributions from retirement plans and IRAs may achieve income tax savings, in case income tax rates increase in 2013.
- Tax deductions, ordinary losses and capital losses deferred to 2013 may result in greater tax savings in 2013 compared to deductions recognized in 2012, in case tax rates increase in 2013.
2. Long Term Capital Gain and Qualified Dividends Tax Rate
Under prior law, the tax rate applicable to an individual’s long term capital gains and qualified dividends was 15% for taxpayers in the 25% ordinary income tax bracket and above. Effective January 1, 2011, the 15% long term capital gain tax rate was scheduled to increase to 20%, and the 15% qualified dividend tax rate was scheduled to increase to 39.6%, but the 15% rates are now retained for 2011 and 2012.
- With the retention of the 15% tax rate on qualified dividends, in the current low interest environment investors may consider dividend-paying stocks as a source of yield to fund cash flow needs. Of course, investors need to consider their risk tolerance to hold dividend-paying stocks, their investment time horizon, desired yield and cash flow needs, and appropriate asset allocation for aggregate retirement and non-retirement plan assets.
- Since IRA and retirement plan distributions are subject to the top 35% ordinary income tax rate, no income tax rate benefit is obtained by using an IRA or retirement plan when investing in qualified dividend-paying investments.
There are three requirements that a qualifying dividend must satisfy to be eligible for the 15% tax rate: (1) the dividend must be from an American company or qualifying (tax treaty) foreign company, (2) the dividend is on the IRS approval list (IRS Publication 550) and (3) the stock must be owned for more than 60 days prior to the "ex-dividend date”.
3. Payroll Tax Provisions
For 2011 and 2012 the Act reduces by two percentage points employees’ Social Security Tax rate on wages and on self-employment income. As a result, employees will pay 4.2% on wages up to $106,000. Self-employed individuals will pay 10.4% on self-employment income up to the same threshold amount plus the additional 2.9% Medicare tax (the 2010 retained rate) on their total self-employment income.
Observation:It should be remembered that, under the Health Care Reform legislation signed by the President earlier in 2010, starting in 2013 individuals whose adjusted gross income for the year exceeds $200,000 ($250,000 for joint filers), whether from wages or otherwise, will also be paying an additional 3.8% Medicare tax on net investment income.
4. Alternative Minimum Tax (“AMT”)
The AMT remains in effect for 2011 and 2012, but the AMT exemption amounts are increased for those years to $74,450 for married individuals filing jointly, $48,450 for single and head of household filers, and $37,225 for married individuals filing separately.
Since it is not clear whether these increased exemptions will apply to 2013 and later years, it may be wise to consider shifting expenses or income subject to AMT adjustments into 2011 and 2012.
- Typical expenses and losses not deductible for AMT purposes – though deductible for regular income tax purposes – include state and local taxes, mortgage interest on home equity debt, medical expenses and miscellaneous itemized deductions, accelerated depreciation, and investment expenses.
- Income recognized for AMT purposes – though not for regular tax purposes – includes, inter alia, income from the exercise of incentive stock options (measured by the stock value at exercise less the exercise price paid) and tax-exempt interest income from private activity bonds.
- AMT adjustments can also arise due to passive income and losses; this is because AMT adjustments need to be considered in calculating a passive loss for AMT purposes.
- Further, there are limitations on net operating loss deductions against AMT income.
5. Individual Tax Credits
The Act extends a number of credits against individual income taxes through December 31, 2012:
American Opportunity Credit
This provides a refundable tax credit up to $2,500 based on expenses for the first four years of undergraduate education.
Enhanced Child Tax Credit
This provides up to $1,000 (rather than reverting to its previous maximum of $500) in partially refundable tax credits for children under the age of 17.
Enhanced Earned Income Credit
This was scheduled to revert to a maximum of two dependents.
Adoption Tax Credit
The credit of $13,170 (scheduled to revert to a maximum of $5,000 in 2013) is extended through 2012.
Dependent and Child Care Tax Credit
This is extended at higher maximums of $3,000 for one child and $6,000 for two or more children.
6. Individual Tax Deductions
The Act extends a number of provisions for deductions from individual taxable income through December 31, 2012:
Repeal of the Dollar Limitation on Itemized Deductions
This was previously enacted as a one-year-only repeal in 2010, but the Act suspends for two additional years through the end of 2012 the limitation on itemized deductions for higher-income earners.
Repeal of the Personal Exemption Phase-out
Likewise, the temporary one-year repeal of the phase-out for personal exemptions is extended for two additional years.
Deduction for Student Loan Interest
This is extended for two more years, but after 2012 the deduction is scheduled to revert to previous tax law under which interest on a student loan is deductible only for the first 60 months of repayment.
Sales Tax Deduction
This is an optional itemized deduction in lieu of the deduction for state income taxes.
Observation: This option is retroactively available for 2010 and remains available in 2011, but then expires for 2012 and later years. This same 2010 and 2011 applicability also limits the other deduction provisions listed just below.
Tuition and Fees Deduction
For 2010 and 2011, this deduction may be more useful than the American Opportunity or Lifetime Learning tax credits.
Classroom Expense Deduction
For teachers, this continues to apply for 2010 and 2011.
Charitable Contributions of IRAs
For 2010 and 2011, an individual at least 70.5 years old may donate up to $100,000 from his or her IRAs directly to qualified charities in trustee-to-trustee transfers.
Planning Observation: This charitable gift bypasses reporting on tax returns (no IRA income is reported and no charitable deduction is reported), which can keep a charitable person's adjusted gross income lower and thereby avoid an increase in Medicare insurance premiums.
2010 Federal Tax Filing Issues
The Act’s changes may cause filing delays for certain taxpayers. The Internal Revenue Service announced in late December 2010 that the filing of 2010 tax filings by taxpayers will most likely not be possible until mid-to-late February for those who itemize deductions and file Schedule A. Additionally, the IRS release of 2010 forms will be delayed for claiming tuition and fees deductions, and casualty and theft losses.
For further information on these or other provisions of the Act, please contact Timothy Speiss or another EisnerAmper tax professional.
This publication is intended to provide general information to our friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.