TEMPORARY EXTENSION OF CERTAIN TAX RELIEF
TEMPORARY EXTENSION OF INDIVIDUAL AMT RELIEF
TEMPORARY ESTATE TAX RELIEF
TEMPORARY EXTENSION OF INVESTMENT INCENTIVES
TEMPORARY EMPLOYEE PAYROLL CUT
INDIVIDUAL TAX RELIEF
BUSINESS TAX RELIEF
President Obama signed into law the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (the Act) on Dec. 17, 2010. The legislation represents an $858 billion tax deal negotiated by the president and Republican leaders. The heart of the Act is a two-year extension of certain tax cuts enacted when George W. Bush served as president and temporary estate tax relief. The Act ultimately defers decisions on expiring tax cuts and sets the table for the possibility of major tax reform during the next few years to broaden the tax base and reduce tax rates. Certain provisions of the Act are summarized below.
TEMPORARY EXTENSION OF CERTAIN TAX RELIEF
- Marginal individual income tax rate reductions. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) created a 10 percent regular income tax bracket for a portion of taxable income that was previously taxed at 15 percent. EGTRRA also reduced the other regular income tax rates. The otherwise applicable regular income tax rates of 28 percent, 31 percent, 36 percent and 39.6 percent were reduced to 25 percent, 28 percent, 33 percent and 35 percent, respectively. These provisions of EGTRRA were scheduled to expire for taxable years beginning after Dec. 31, 2010. The Act extends the 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent individual income tax rates for two years (through 2012).
- Marriage penalty relief. The Act provides for continued marriage penalty relief. The Act increases the basic standard deduction for a married couple filing a joint return to twice the basic standard deduction for an unmarried individual filing a single return, for two years (through 2012), and increases the size of the 15 percent regular income tax rate bracket for a married couple filing a joint return to twice the 15 percent regular income tax rate bracket for an unmarried individual filing a single return, for two years (through 2012).
- Reduced rate on capital gains. Since 2008, the tax rate on long-term capital gains has been zero percent for individuals in the 10 percent and 15 percent income tax brackets and 15 percent for everyone else. However, those rates were scheduled to expire at the end of 2010, with the result that in 2011 the long-term capital gains tax rate would have risen to 20 percent (10 percent for taxpayers in the 15 percent tax bracket) if Congress had not acted. The Act extends, for two additional years (through 2012), the zero percent and 15 percent long-term capital gains tax rates.
- Reduced rate on dividends. Since 2003, “qualified dividends” have been taxed at the same rates that apply to long-term capital gains. Qualified dividend income generally includes dividends received from domestic corporations and qualified foreign corporations. The rates of tax on qualified dividends were also scheduled to expire at the end of 2010, so that beginning in 2011, taxes on qualified dividends would have returned to the rates that were in effect before 2001, and all dividend income received in 2011 would have been taxed as ordinary income. The Act extends, for two additional years (through 2012), the tax regime in effect since 2003 for qualified dividends.
- Limitation on itemized deductions and the personal exemption phaseout. Prior to 2010, the total amount of otherwise allowable itemized deductions (other than medical expenses; investment interest; and casualty, theft or wagering losses) was limited for upper-income taxpayers, and the deduction for personal exemptions was reduced or eliminated for taxpayers with incomes over certain thresholds. Under EGTRRA, there is no overall limitation on itemized deductions or personal exemption phaseout in 2010. The Act provides that the overall limitation on itemized deductions and the personal exemption phaseout does not apply for two additional years (through 2012).
- Child tax credit. The Act extends the $1,000 child tax credit and allows the child tax credit against an individual’s regular income tax and alternative minimum tax (AMT) for two years (through 2012). The Act also extends the EGTRRA repeal of a prior-law provision that reduced the refundable child credit by the amount of the AMT for two years (through 2012). Additionally, the Act extends the earned income formula for determining the refundable child credit, with the earned income threshold of $3,000. Finally, the Act extends the rule that the refundable portion of the child tax credit does not constitute income and is not treated as resources for purposes of determining eligibility or the amount or nature of benefits or assistance under any federal program or any state or local program financed with federal funds for two years (through 2012).
- Earned income tax credit simplification. The Act extends for two years certain earned income tax credit provisions adopted by EGTRRA and designed to simplify the credit.
- Education incentives; employer-provided educational assistance. The Act extends for two years numerous educational incentives, including: (i) the income and wage exclusion for (a) awards under the National Health Service Corps Scholarship Program; the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance Program and (b) employer-provided educational assistance (up to $5,250 annually); (ii) the student loan interest deduction; and (iii) Coverdell education savings accounts.
The Act also delays the EGTRRA sunset as it applies to the expansion of the small government unit exception to arbitrage rebate and allowing issuance of tax-exempt private activity bonds for public school facilities.
- Adoption tax credit; employer-provided child care and dependent care credits. The Act extends the EGTRRA expansion of the adoption credit and the exclusion from income for employer-provided adoption assistance for one year (2012). For 2012, the maximum benefit is $12,170 (indexed for inflation after 2010). The adoption credit and exclusion are phased out ratably for taxpayers with modified adjusted gross income between $182,520 and $222,520 (indexed for inflation after 2010). The Act also extends, through 2012, the employer-provided child care tax credit and the dependent care tax credit for two years.
- American Opportunity Tax Credit. The Act includes a two-year extension of the American Opportunity Tax Credit for qualifying college costs.
TEMPORARY EXTENSION OF INDIVIDUAL AMT RELIEF
- Increased AMT exemption amount. The Act increases the individual AMT exemption amounts for 2010 and 2011 (rather than allowing them to decrease to pre-EGTRRA statutory levels). Specifically, for tax years beginning in 2010, the AMT exemption amounts are: (i) $72,450 for married couples filing a joint return and for surviving spouses; (ii) $47,450 for individuals who are not married or for a surviving spouse; and (iii) $36,225 (up from $35,475 in 2009) for married individuals filing separate returns.
For tax years beginning in 2011, the AMT exemption amounts will be further increased to: (i) $74,450 for married couples filing a joint return and for surviving spouses; (ii) $48,450 for individuals who are not married or for a surviving spouse; and (iii) $37,225 for married individuals filing separate returns.
- AMT tax relief for nonrefundable personal credits. The Act extends the ability of individual taxpayers to offset their entire regular tax liability and AMT liability by the non-refundable personal credits for 2010 and 2011.
TEMPORARY ESTATE TAX RELIEF
- Estate tax applicable exclusion amount and estate tax rate. The Act increases the estate tax applicable exclusion amount from $1 million to $5 million for decedents dying after Dec. 31, 2010, and decreases the highest estate tax rate from 55 percent to 35 percent.
- Basis adjustments. The Act reinstates the “stepped-up” basis rules so that, for a decedent dying after Dec. 31, 2010, a recipient of property acquired from the decedent will receive property with a basis equal to the fair market value of the property on the date of the decedent’s death. For decedents dying in 2010, however, the executor of the decedent’s estate has the option to elect: (i) an estate tax (with a $5 million applicable exemption amount at a top tax rate of 35 percent) and a “step-up” in basis; or (ii) no estate tax and the modified carry-over basis rules that were previously in effect for decedents dying in 2010.
The Act also provides for an extension of no more than nine months from the date of the enactment of the Act to: (i) file an estate tax return; (ii) pay any estate tax that may be due; and (iii) make any qualified disclaimer of an interest in property passing by reason of the individual’s death.
- Lifetime gift tax exemption. For gifts made after Dec. 31, 2010, the Act provides that the lifetime gift tax exemption is increased to $5 million at a top tax rate of 35 percent. For gifts made in 2010, the Act maintains the current $1 million lifetime gift tax exemption at a top tax rate of 35 percent.
- Generation-skipping transfer tax. In 2010, the Act unifies the generation-skipping transfer tax exemption with the estate tax applicable exclusion amount such that the generation-skipping transfer tax exemption is retroactively increased to $5 million in 2010 at a top tax rate of zero percent. For generation-skipping transfers made after Dec. 2010, however, the generation-skipping transfer tax exemption is maintained at $5 million, but the top tax rate is increased to 35 percent.
- Portability of estate tax applicable exclusion amount and lifetime gift tax exemption. For individuals dying after Dec. 31, 2010, the Act permits a surviving spouse to utilize the predeceased spouse’s unused estate tax applicable exclusion amount. Thus, a married couple could collectively transfer up to $10 million at their deaths without any estate tax consequences. However, in order for a surviving spouse to use the predeceased spouse’s unused estate tax applicable exclusion amount, the executor of the predeceased spouse’s estate must file an estate tax return to elect the portability of the predeceased spouse’s unused estate tax applicable exclusion amount.
Similarly, the Act creates a portability feature for gift tax purposes, such that a surviving spouse may elect to use a predeceased spouse’s unused lifetime gift tax exemption. Thus, a married couple can collectively make up to $10 million in lifetime gifts without any gift tax consequences. The Act does not create a portability feature for generation-skipping transfer tax purposes.
- Sunset of the Act. The Act is only a two-year extension of the EGTRAA provisions applicable to the gift, estate and generation-skipping transfer taxes. Thus, unless Congress passes additional legislation in the next two years, the pre-EGTRAA gift, estate and generation-skipping transfer tax rules will go into effect for decedents dying, and gifts and generation-skipping transfers made after Dec. 31, 2012, such that: (i) the estate tax applicable exclusion amount will be $1 million at a top tax rate of 55 to 60 percent; (ii) the lifetime gift tax exemption will be $1 million at a top tax rate of 55 percent; and (iii) the generation-skipping transfer tax exemption will be $1.36 million (adjusted for inflation) at a top tax rate of 55 percent.
TEMPORARY EXTENSION OF INVESTMENT INCENTIVES
- Extension and expansion of bonus depreciation. The Act extends and expands the additional first-year depreciation to equal 100 percent of the cost of qualified property placed in service after Sept. 8, 2010, and before Jan. 1, 2012. It also provides for a 50 percent first-year additional depreciation deduction for qualified property placed in service after Dec. 31, 2011, and before Jan. 1, 2013. The extension of the placed-in-service deadline for qualified property also extends the eligibility period for the exemption from the alternative minimum tax depreciation adjustment, as well as eligibility for the $8,000 increase in the first-year depreciation limit for passenger automobiles.
- Temporary extension of increased small business expensing. For taxable years beginning in 2012, the maximum amount a taxpayer may expense is $125,000 of the cost of qualifying property placed in service for the taxable year (the maximum amount had been scheduled to revert to $25,000 in 2012). The $125,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $500,000. The $125,000 and $500,000 amounts are indexed for inflation. In addition, the treatment of off-the-shelf computer software as qualifying property is extended, as is the provision permitting a taxpayer to amend or irrevocably revoke an election for a taxable year under section 179 without the consent of the Commissioner for one year (through 2012).
TEMPORARY EMPLOYEE PAYROLL TAX CUT
- Temporary employee payroll tax cut. The Act reduces the employee old age, survivors and disability insurance (OASDI) tax rate under the Federal Insurance Contributions Act by two percentage points to 4.2 percent for one year (2011). Similarly, the provision reduces the OASDI tax rate for self-employed individuals by two percentage points to 10.4 percent for taxable years that begin in 2011. A similar reduction applies to the railroad retirement tax. The rate reduction is not taken into account in determining the deduction allowed to self-employed individuals for the full amount of the employer portion of Self-Employment Contributions Act taxes. Thus, the deduction for 2011 remains at 7.65 percent of self-employment income (determined without regard to the deduction).
INDIVIDUAL TAX RELIEF
- Tax-free distributions from individual retirement plans for charitable purposes. The Pension Protection Act of 2006 amended the individual retirement account (IRA) distribution rules to allow tax-free treatment of distributions from IRAs in which the distributions are donated to charity. Under pre-Act law, the tax-free qualified charitable distribution rules applied only to distributions made in tax years beginning in 2006 through 2009. The Act extends the exclusion for qualified charitable distributions to distributions made in tax years beginning after Dec. 31, 2009, and before Jan. 1, 2012. Under a special rule, for purposes of both: (i) the tax-free qualified charitable distribution rules; and (ii) the required minimum distribution rules as they apply to IRAs and individual retirement annuities, any qualified charitable distribution made after Dec. 31, 2010, and before Feb. 1, 2011, will be deemed to have been made on Dec. 31, 2010, if the IRA owner so elects at such time and in such manner as the IRS will prescribe.
Therefore, a qualified charitable distribution made in January 2011 is permitted to be: (i) treated as made in the taxpayer’s 2010 tax year, and is thus permitted to count against the 2010 $100,000 limitation on the exclusion; and (ii) treated as made in the 2010 calendar year, and is thus permitted to be used to satisfy the taxpayer’s required minimum distribution for 2010.
- Deduction of state and local sales taxes. The Act retroactively extends the election to claim an itemized deduction for state and local sales taxes.
- Contributions of capital gain real property for conservation purposes. Contributions by individuals of appreciated capital gain property to certain charities generally are deductible up to 30 percent of the taxpayer’s contribution base. “Qualified conservation contributions” made by individuals in tax years beginning after Dec. 31, 2005, are deductible to the extent that the aggregate of those contributions is not larger than the excess of 50 percent of the taxpayer’s contribution base over the amount of all other allowable charitable contributions. If the individual is a qualified farmer or rancher for the tax year in which the qualified conservation contribution is made, the contribution is allowed to the extent that the aggregate of those contributions is not larger than the excess of 100 percent (rather than 50 percent) of the taxpayer’s contribution base over the amount of all other allowable charitable contributions. Under pre-Act law, the rules just summarized did not apply to contributions made in tax years beginning after Dec. 31, 2009. The Act extends the above rules for two years for contributions made in tax years beginning before 2012.
- Above-the-line deduction for qualified tuition and related expenses. Under pre-Act law, certain individuals were allowed an above-the-line deduction for qualified tuition and related expenses for higher education, paid by the individual during the taxable year. The provision extends the qualified tuition deduction for two years, so that generally it is available for taxable years beginning before Jan. 1, 2012.
- Other provisions regarding individual tax relief. The Act also includes other provisions regarding individual tax relief, including: (i) a deduction for certain expenses of elementary and secondary school teachers; (ii) look-through of certain regulated investment company stock in determining gross estate of nonresidents; (iii) parity for exclusion from income for employer-provided mass transit and parking benefits; and (iv) the treatment of refunds in the administration of federal programs and federally assisted programs.
BUSINESS TAX RELIEF
- New markets tax credit. The Act extends the new markets tax credit for two years, through 2011, subject to a $3.5 billion maximum annual amount. Therefore, for each of the 2010 and 2011 calendar years, up to $3.5 billion in qualified equity investments is permitted. In addition, the Act extends the carry-over period for unused new markets tax credits for two years, through 2016.
- Research credit. The Act retroactively extends the research credit to apply to amounts paid or incurred before Jan. 1, 2012. Under pre-Act law, a taxpayer was entitled to a research credit for qualifying amounts paid or incurred before Jan. 1, 2010. The credit generally was equal to 20 percent of the amount by which the taxpayer’s qualified research expenses exceeded a specific base. Because the extension of the research credit is retroactive to include amounts paid or incurred after Dec. 31, 2009, taxpayers such as fiscal-year corporations that paid or incurred amounts for research credits in 2010 and already filed returns for a fiscal year that includes part of 2010 might consider filing an amended return to claim a refund for the amount of the additional tax paid because of not claiming amounts now eligible for the credit.
- Fifteen-year straight-line cost recovery. The Act extends the rules that provide for straight-line depreciation over a 15-year recovery period for qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property, for two years, to apply to property placed in service on or before Dec. 31, 2011.
- Enhanced charitable deduction for contributions of food and book inventory. The Act extends the special deduction rules for apparently wholesome food and qualified books, for two years, to contributions made before Jan. 1, 2012. C corporations that make a “qualified contribution” of inventory-type property to a 501(c)(3) charitable organization that will use it for care of the ill, the needy or infants are entitled to a deduction equal to the lesser of the contributor’s basis plus half of the property’s appreciation, or twice the property’s basis (above-basis deduction). However, special deduction rules also provide that: (i) any taxpayer, whether or not a C corporation, engaged in a trade or business is eligible to claim the above-basis deduction for donations of food inventory, but only if the food is “apparently wholesome food;” and (ii) a “qualified book contribution” is treated as a qualified contribution.
For purposes of the foregoing rule, a qualified book contribution means a charitable contribution of books, but only if the donee is a public school that satisfies specified requirements; the donee provides elementary or secondary education; and the donee satisfies specified certification requirements regarding the donated books and its use of those books.
- Enhanced charitable deduction for corporate contributions of computer inventory. The Act extends the rule that allows C corporations that make a qualified contribution of computer technology or equipment to certain exempt organizations and libraries to claim an above-basis deduction to contributions made before Jan. 1, 2012.
- Expensing of environmental remediation costs. The Act extends the provision permitting the expensing of qualified environmental remediation expenditures (i.e., expenditures that would otherwise be chargeable to capital account and were incurred in connection with the abatement or control of “hazardous substances” at a “qualified contaminated site”), for two years, to include expenditures paid or incurred before Jan. 1, 2012.
- Deduction relating to domestic production activities in Puerto Rico. The Act extends the provisions that allow the special domestic production activities rules to apply to gross receipts from Puerto Rico, for two years, to the first six taxable years of a taxpayer beginning after Dec. 31, 2005, and before Jan, 1, 2012. Generally, trade or business activities must be conducted in the U.S. to be eligible for the domestic production activities deduction. However, under a special rule, the U.S. includes Puerto Rico for any taxpayer with gross receipts from sources within Puerto Rico, but only if all of the taxpayer’s Puerto Rico-sourced gross receipts are taxable under the federal income tax for individuals or corporations.
- Payments to controlling exempt organizations. The Act extends for two years the special tax treatment of certain payments to controlling exempt organizations to payments received or accrued before Jan. 1, 2012. Under the provision, payments of rent, royalties, annuities or interest income by a controlled organization to a controlling organization pursuant to a binding written contract in effect on Aug. 17, 2006 (or renewal of such a contract on substantially similar terms), may be includable in the unrelated business taxable income of the controlling organization only to the extent that the payment exceeds the amount of the payment determined under the principles of Section 482 (i.e., at arm’s length). Any such excess is subject to a 20 percent penalty on the larger of such excess, determined without regard to any amendment or supplement to a return of tax, or such excess determined with regard to all such amendments and supplements.
- Exceptions for active financing income. The Act extends for two years (for taxable years beginning before 2012) the present-law temporary exceptions from subpart F foreign personal holding company income; foreign base company services income; and insurance income for certain income that is derived in the active conduct of a banking, financing or similar business, or in the conduct of an insurance business.
- Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules. Under the “look-through rule,” dividends, interest (including factoring income that is treated as equivalent to interest), rents and royalties received by one controlled foreign corporation (CFC) from a related CFC are not treated as foreign personal holding company income to the extent attributable or properly allocable to income of the payor that is neither subpart F income, nor treated as effectively connected income. The look-through rule is effective for taxable years of foreign corporations beginning before Jan. 1, 2010, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end. The Act extends for two years the application of the look-through rule to taxable years of foreign corporations beginning before Jan. 1, 2012, and for taxable years of U.S. shareholders with or within which such taxable years of such foreign corporations end.
- Basis adjustment to stock of S corporations making charitable contributions of property. If an S corporation contributes money or other property to a charity, each shareholder takes into account the shareholder’s pro rata share of the contribution in determining its own income tax liability and reduces the basis in the stock of the S corporation by the amount of the charitable contribution that flows through to the shareholder. The Act extends the rule that the decrease in a shareholder’s basis in his S corporation stock, by reason of a charitable contribution made by the S corporation, equals the shareholder’s pro rata share of the adjusted basis of the contributed property rather than the fair market value of such property for contributions in tax years beginning before Jan. 1, 2012.
- Empowerment zone tax incentives. The Act extends for two years, through Dec. 31, 2011, the period for which the designation of an empowerment zone is in effect, thus extending for two years the empowerment zone tax incentives, including the wage credit, accelerated depreciation deductions on qualifying equipment, tax-exempt bond financing, and deferral of capital gains tax on the sale of qualified assets sold and replaced. In the case of a designation of an empowerment zone – the nomination for which included a termination date that is Dec. 31, 2009 – termination will not apply with respect to such designation, if the entity that made such nomination amends the nomination to provide for a new termination date in such manner as the Secretary of the Treasury may provide. The Act also extends for two years, through Dec. 31, 2016, the period for which the percentage exclusion for qualified small business stock (of a corporation that is a qualified business entity) acquired on or before Feb. 17, 2009 is 60 percent. Gain attributable to periods after Dec. 31, 2016, for qualified small business stock acquired on or before Feb. 17, 2009, or after Dec. 31, 2011, is subject to the general rule, which provides for a percentage exclusion of 50 percent.
- Work opportunity credit. The Act extends the work opportunity tax credit (available on an elective basis for employers hiring individuals from one or more of nine targeted groups) for four months (for individuals who begin work for an employer after Aug. 31, 2011, and before Jan. 1, 2012). The amount of the credit available to an employer is determined by the amount of qualified wages paid by the employer. Generally, qualified wages consist of wages attributable to service rendered by a member of a targeted group during the one-year period beginning on the day the individual begins work for the employer (two years in the case of an individual in the long-term family assistance recipient category).
- Qualified zone academy bonds. The Act extends the qualified zone academy bond program for one year and authorizes issuance of up to $400 million of qualified zone academy bonds for 2011. The issuer election to receive a payment in lieu of providing a tax credit to the holder of the qualified zone academy bond is not available for bonds issued with the 2011 national limitation. The provision has no effect on bonds issued with limitation carried forward from 2009 or 2010.
- Mortgage insurance premiums. The Act extends the deduction for private mortgage insurance premiums for one year (only with respect to contracts entered into after Dec. 31, 2006). Thus, the provision applies to amounts paid or accrued in 2011 (and not properly allocable to any period after 2011).
- Temporary exclusion of 100 percent of gain on small business stock. The Act extends the 100 percent exclusion of the gain from the sale of certain small business stock acquired at original issue and held for at least five years, as well as the exception from minimum tax preference treatment, for one year (for stock acquired before Jan. 1, 2012).
- Other provisions regarding business tax relief. The Act also includes other provisions regarding business tax relief, including:
- The Indian employment credit.
- A railroad track maintenance credit.
- A mine rescue team training credit.
- An employer wage credit for employees who are active duty members of the uniformed services.
- A seven-year recovery period for motorsports entertainment complexes.
- Accelerated depreciation for business property on an Indian reservation.
- An election to expense mine safety equipment.
- Special expensing rules for certain film and television productions.
- The treatment of certain dividends of regulated investment companies.
- Regulated Investment Company qualified investment entity treatment under the Foreign Investment in Real Property Tax Act of 1980.
- Tax incentives for investment in the District of Columbia.
- A temporary increase in limit on cover-over of rum excise taxes to Puerto Rico and the Virgin Islands.
- An American Samoa economic development credit.
- Energy provisions not described in this newsletter. The Act also includes provisions regarding the temporary extension of certain energy incentives, including:
- Incentives for biodiesel and renewable diesel.
- A credit for refined coal facilities.
- A new energy-efficient home credit.
- Excise tax credits and outlay payments for alternative fuel and alternative fuel mixtures.
- A special rule for sales or dispositions to implement FERC or state electric restructuring policy for qualified electric utilities.
- A suspension of the limitation on percentage depletion for oil and gas from marginal wells.
- An extension of grants for specified energy property in lieu of tax credits.
- An extension of provisions related to alcohol used as fuel.
- The energy-efficient appliance credit.
- A credit for nonbusiness energy property.
- Provisions relating to alternative fuel vehicle refueling property.
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