Insert



INTRODUCTION

The year of 2010 saw a host of changes in the tax law. The first round of legislation came in March with the enactment of the massive health care bill, formally called the Patient Protection and Affordable Care Act, as amended by the Health Care and Reconciliation Act of 2010 (the Health Care Act). Although this legislation was aimed at health insurance reform, there were a number of provisions that affected the Internal Revenue Code. March also was the stage for the passage of the Hiring Incentives to Restore Employment Act (HIRE Act). This Act included a number of tax incentives for job creation and retention. A few months later, on September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010 (the Jobs Act). The year closed for tax legislation on December 17, 2010 when President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (hereinafter referred to as the Act or the 2010 Act or Tax Relief Act). All of the legislation impacted the tax law but none more so than the Tax Relief Act. The Act extends for two years (2011 and 2012) the so-called Bush tax cuts contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

Upon its passage in May, 2001, EGTRRA was hailed by its proponents as the biggest tax cut in history. It made sweeping changes in the tax law, including cuts in the tax rates, marriage penalty relief and repeal of the estate tax. Importantly, however, EGTRRA contained a sunset provision; that is, all provisions of the Act were set to expire at the close of 2010. In the supplement to the 2002 edition for that year we wrote:

Perhaps the most interesting part of the Economic Growth and Tax Relief Reconciliation Act of 2001 is the surprise ending. Virtually all of the changes made by the Act are repealed in 2011. The repeal was necessary to satisfy Senate budget rules. Consequently, the entire set of tax breaks just enacted will expire in 2011 and will have to be reinstated by a future Congress.

While most believed that action on the EGTRRA provisions would occur long before the 2011 sunset, Congress waited till the final weeks of 2010 to move. Congress responded with enactment of The Tax Relief Act. For the most part, the Act simply continues the current law—continues EGTRRA—through 2011 and 2012. Thus, in 2013, Congress will get another chance to determine whether the EGTRRA changes should survive.

Perhaps the most important provisions of the Tax Relief Act are those that retain the current tax rates as well as the favorable 15 percent rate for long-term capital gains and qualified dividends. No doubt, the provision that will be felt immediately by working Americans is the temporary cut in social security taxes. All employed and self employed individuals get immediate tax relief from employment taxes with a 2 percentage point cut in the social security tax rate for 2011 (from 6.2% to 4.2% for employees and 12.4% to 10.4% for self-employed persons). In addition, Congress passed a two-year fix for the alternative minimum tax that ensures millions will not be hit by the tax. The Act also contains several new tax breaks. At the top of the list is a provision that generally allows businesses to deduct immediately—rather than depreciate—the cost of new property placed in service after September 8, 2010 and before January 1, 2012. Finally, the Act addresses the repeal of the estate tax. The new law does not go so far as to repeal the estate and gift tax. However, the revisions ensure that only the wealthiest of individuals—those with net wealth exceeding $5,000,000 ($10,000,000 for married couples) will be subject to the tax. The new law also extends many expired and expiring tax breaks for businesses and individuals.

This supplement focuses primarily on changes made by the Tax Relief Act. Since most provisions of the health legislation do not become effective until later years the discussion is limited to changes on the immediate horizon as well as those that have already been the subject of debate (e.g., imposition of a Medicare tax on those with substantial investment income).

The changes introduced by the new laws are reflected in the following pages and are referenced to the 2011 Edition by chapter and page. In addition, this update includes a discussion of other important developments that have occurred since the book went to press.

SUPPLEMENT TO ACCOMPANY

INDIVIDUAL TAXATION

2011 EDITION

Pratt and Kulsrud

Changes Introduced by the:

Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,

Small Business Jobs Act of 2010

Hiring Incentives to Restore Employment Act of 2010

Patient Protection and Affordable Care Act of 2010

Pratt-Kulsrud Tax Series

Cengage Corporation

All rights reserved. The contents or parts thereof, may be reproduced for classroom use

with Individual Taxation 2011 Edition by Pratt and Kulsrud, provided such reproductions

bear copyright notice and the number reproduced does not exceed the number of students

using the text, but may not be reproduced in any form for any other purpose without

written permission of the publisher

INSIDE FRONT COVER: 2011 Tax Rates (as adjusted for inflation)

2011 Tax Rates Single

If taxable income is % on Of the

Over But not over The tax is + Excess Amount over

$ 0 $ 8,500 $ 0.00 10% $ 0

8,500 34,500 850.00 15 8,500

34,500 83,600 4,750.00 25 34,500

83,600 174,400 17,025.00 28 83,600

174,400 379,150 42,449.00 33 171,850

379,150 110,016.50 35 379,150

2011 Tax Rates Married Filing Jointly

If taxable income is % on Of the

Over But not over The tax is + Excess Amount over

$ 0 $ 17,000 $ 0.00 10% $ 0

17,000 69,000 1,700.00 15 17,000

69,000 139,350 9,500.00 25 69,000

139,350 212,300 27,087.50 28 139,350

212,300 373,650 47,513.50 33 212,300

379,150 102,574.00 35 379,150

2011 Head of Household

If taxable income is % on Of the

Over But not over The tax is + Excess Amount over

$ 0 $ 12,150 $ 0.00 10% $ 0

12,150 46,250 1,215.00 15% 12,150

46,250 119,400 6,330.00 25% 46,250

119,400 193,350 24,617.50 28% 119,400

193,350 379,150 45,323.50 33% 193,350

379,150 106,637.50 35% 379,150

2011 Married, Filing Separate [§1(d)]

If taxable income is % on Of the

Over But not over The tax is + Excess Amount over

$ 0 $ 8,500 $ 0.00 10% $ 0

8,500 34,500 850.50 15% 8,500

34,500 69,675 4,750.00 25% 34,500

69,675 106,150 13,543.75 28% 69,675

106,150 189,575 23,756.75 33% 106,150

189,575 51,287.00 35% 189,575

|Standard Deductions and Exemptions |

| |Standard Deduction |

| |Amount |

|Filing Status |2011 |2010 |

|Single | $ 5,800 | $ 5,700 |

|Unmarried head of household | 8,500 | 8,400 |

|Married persons filing a joint return (and surviving spouses) | 11,600 | 11,400 |

|Married persons filing a separate return | 5,800 | 5,700 |

| |

| |Exemption Amount |

| |2011 |2010 |

|Personal exemption | $3,700 | $3,650 |

|Dependency exemption | 3,700 | 3,650 |

|Individual who can be claimed as dependent on another’s return | 950 | 950 |

CHAPTER 1: AN OVERVIEW OF FEDERAL TAXATION

Page 1-5

Federal Wealth Transfer Taxes

Due to an improbable chain of political events, the estate tax was allowed to expire in 2010. In effect, rates fell from 45% in 2009 to zero in 2010—causing some taxpayers to cling to life (or their family members to delay pulling plugs) until 2010 to save money for their heirs. However, before the obituary for the tax could be written, it was quickly resurrected. On its resurrection, the Wall Street Journal noted, “[t]hus would end one of the sorriest episodes in U.S. tax history: the Great Estate-Tax Lapse of 2009” (December 11, 2010).

For those who died in 2010 and who would have been subject to the estate tax, the temporary death of the death tax was no doubt a huge windfall. One possible benefactor was George Steinbrenner, the owner of the New York Yankees baseball franchise, who died in July, 2010. Initial estimates indicated his estate, which primarily consisted of the Yankee baseball team, was worth over $1.4 billion. Had Steinbrenner died in 2009 his estate tax would have been roughly $630,000,000 (45% x $1.4 billion). His timely death produced huge savings. However, while substantial estate taxes were saved by those who died in 2010, there was a drawback of the repeal: the basis of property to the decedent’s heirs generally carried over to the heirs rather than being stepped-up to fair market value.

Although Congress revived the estate tax for 2011 and 2012, it made major changes. Generally, the tax applies only to decedents with net wealth (assets minus liabilities) exceeding $5,000,000 ($10,000,000 for married couples). These changes are discussed in greater detail below.

Page 1-8

Tax Rates

The new law addresses the increase in the tax rates that was scheduled for 2011. Without action, the rates were scheduled to rise to pre-EGTRRA levels: 15%, 28%, 31%, 36% and 39.6%. In addition, the 15% tax bracket for joint filers and qualified surviving spouses was scheduled to drop to 167% of the 15% tax bracket for individual filers. Under the new law, the tax rate schedules for individuals will not increase. They remain at 10%, 15%, 25%, 28%, 33% and 35% for two additional years through 2011 and 2012. In addition, the size of the 15% tax bracket for joint filers and qualified surviving spouses will remain at 200% of the 15% tax bracket for individual filers through 2012. The rates for 2011 as adjusted for inflation are shown below:

Single Taxpayers Married Taxpayers

Tax Rate Taxable Income Taxable Income

10% $ 0 – $ 8,500 $ 0 – $ 7,000

15% 8,500 – 34,500 17,000 – 69,000

25% 34,500 – 83,600 69,000 – 139,350

28% 83,600 – 174,400 139,350 – 212,300

33% 174,400 – 379,150 212,300 – 379,150

35% Over 379,150 Over 379,150

The lower income tax rates are set to expire after 2012. See “Inside Front Cover” above for the 2011 tax rates.

President Obama has promised that he will make the sunset of the two highest brackets an issue in the 2012 presidential campaign. If that were to occur, the top tax rates would move to 36% and 39.6% from 33% and 35%. Another rate issue surely to see debate will be the status of the 2013 health care (i.e., Medicare) taxes whereby higher-income individuals (i.e., above a $200,000 threshold for single and head-of-household filers, and a $250,000 threshold for joint filers) will be subject to an additional 0.9 percent Medicare tax on earned income (moving the tax from 1.45 to 2.35 percent) and a 3.8 percent Medicare tax on unearned income. Note that unearned income is currently not subject to either Medicare or Social Security taxes.

The rate cut will provide real benefits for working America. When the 2 percentage point payroll tax cut (discussed below) is added to the extension of the individual rate cuts, many individuals will see a significant increase in take-home income available to them in 2011 over what would have been the case without the Tax Relief Act.

Page 1-14

Wealth Transfer Taxes

The Bush tax cuts, officially contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), provided for the gradual reduction of the estate tax beginning in 2002 and in its outright repeal in 2010. However, the law was structured in such a way that if Congress did nothing, the estate tax was to be reinstated in 2011 in the same form as before the Bush legislation. As a practical matter, most believed that repeal would never occur and ultimately Congress would reach some type of compromise that would extend the estate tax in some modified form. But, the unthinkable actually occurred and the estate tax was repealed—but only for one year, 2010. The new law resurrects the estate tax but only for 2011 and 2012, leaving everyone to wonder what will happen in 2013. If Congress does not act, in 2013, the exemption (i.e., unified credit equivalent) is scheduled to decrease once again to only $1 million with a top rate of 55 percent.

Although Congress reestablished the estate tax for 2011 and 2012, significant changes were made in both the estate tax and the gift tax. Under the new law, the estate tax as well as the gift has limited reach. The revised estate tax applies only to decedent’s with net wealth (assets minus liabilities) exceeding $5,000,000.

The new law creates a new “portability” rule that allows a surviving spouse to use the unused credit of his or her last spouse. The effect of this operates so that married couples normally will not be taxed unless their estate exceeds $10,000,000.

(Note: technically the estate tax was reinstated for 2010 with a $5,000,000 exemption, a top rate of 35% and a basis for inherited property of fair market value at date of death. Estates for those dying in 2010 that want to avoid paying estate taxes and accept the modified carryover basis rules must elect not to pay the taxes. In other words, estates that do nothing are subject to revived estate tax rules. However, since the vast majority of individuals dying in 2010 will have estates less than the taxable threshold, they will pay no estate taxes and the basis of property passing to their heirs will be their fair market value at date of death.)

Page 1-14

The gift tax exclusion for 2011 remains at $13,000.

For 2010 the taxable threshold at which cumulative taxable gifts are taxed is $1,000,000. The Act increases the threshold temporarily to $5,000,000 for 2011 and 2012. Although the gift tax exemption remains at $1,000,000 for 2010, the top gift tax rate in 2010 is reduced to 35% as is the estate tax rate.

Page 1-15

Under the new law, the top rate for the gift tax and the estate tax for 2010, 2011 and 2012 is 35%. The gift and estate tax rates are shown below

ESTATE AND GIFT TAX RATES 2010

If taxable transfer is Of the

Over But not over Tax liability Amount over

$ 0 $10,000 18% $ 0

10,000 20,000 $1,800 + 20% 10,000

20,000 40,000 3,800 + 22% 20,000

40,000 60,000 8,200 + 24% 40,000

60,000 80,000 13,000 + 26% 60,000

80,000 100,000 18,200 + 28% 80,000

100,000 150,000 23,800 + 30% 100,000

150,000 250,000 38,800 + 32% 150,000

250,000 500,000 70,800 + 34% 250,000

500,000 750,000 155,800 + 35% 500,000

Unified Credit. The unified credit for the estate tax for 2010 and 2011 is $1,730,800 and offsets the tax on transfers of $5,000,000 as shown below.

Taxable estate $5,000,000

Estate tax

Tax on $500,000 $ 155,800

Tax on remaining $4,500,000 x 35% 1,575,000

$1,730,800

Unified credit for 2010, 2011 and 2012 (1,730,800)

Estate tax due $ 0

The credit is adjusted for inflation for decedent’s dying after 2011 (§2010(c)).

While the unified credit for gift tax is the same as the estate tax credit for 2011 and 2012 ($1,730,800 that shelters $5,000,000 in transfers), it is unchanged for 2010. Thus, the unified credit for the gift tax for 2010 remains at $345,800, sheltering only $1,000,000 in taxable gifts.

The unified credit was initially set at $30,000 in 1977 and increased to $47,000 in 1981, eliminating the tax on a gross estate of $175,625. The credit was substantially increased by the Reagan administration in the Economic Recovery Tax Act of 1981, reaching $192,800 in 1987 where it exempted $600,000 from tax. From 1987 through 1996, the taxable threshold remained at $600,000. However, in the Taxpayer Relief Act of 1997, Congress acted again to increase the credit. Beginning in 1998, the credit began to increase gradually to its current level. The Bush tax-cuts contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), decoupled the credit for estate and gift tax, capping the unified credit for the gift tax so that it would exempt $1,000,000 but allowing the credit for estate to grow to exempt $3,500,000 before the repeal of the estate tax in 2010. The changes in the credit and the equivalent exemption are shown in the table below.

             Credit              Exemption Equivalent

Year Estate Tax Gift Tax Estate Tax Gift Tax

1/1/77- 6/30/77 $ 6,000 Same $ 30,000 Same

7/1/77-12/31/77 30,000 Same 120,666 Same

1978 34,000 Same 134,000 Same

1979 38,000 Same 147,333 Same

1980 42,500 Same 161,563 Same

1981 47,000 Same 175,625 Same

1982 62,800 Same 225,000 Same

1983 79,300 Same 275,000 Same

1984 96,300 Same 325,000 Same

1985 121,800 Same 400,000 Same

1986 155,800 Same 500,000 Same

1987-97 192,800 Same 600,000 Same

1998 202,050 Same 625,000 Same

1999 211,300 Same 650,000 Same

2000-01 220,550 Same 675,000 Same

2002-03 345,800 Same 1,000,000 Same

2004-05 555,800 345,800 1,500,000 1,000,000*

2006-08 780,800 345,800 2,000,000 1,000,000

2009 1,455,800 345,800 3,500,000 1,000,000

2010** 1,730,800 345,800 5,000,000 1,000,000

2011-12 1,730,800 Same 5,000,000 Same

* Beginning in 2004, the estate and gift tax exemptions differ. The gift tax exemption was frozen at $1,000,000. However, the 2010 Act reunited the gift tax credit and the estate tax credit so they once again would be the same at $1,730,800, exempting $5,000,000 from tax.

** Estates of individuals dying in 2010 had the option to not pay any estate tax but accept a modified carryover basis. Note that the unified credit for the estate and gift tax differ for 2010 but are once again unified in 2011. Interestingly, top tax rate for both the estate and gift tax beginning in 2010 is 35%.

Portability of the Unused Unified Credit (§ 2010(c)). The 2010 Tax Relief Act introduced the so-called portability rule. According to this rule, any credit/exemption/exclusion that remains unused as of the death of a spouse who dies after 2010 (the “deceased spousal unused exclusion amount”) is portable; that is, the unused amount is generally available for use by the surviving spouse as an addition to the surviving spouse's exemption. Specifically, beginning in 2010 a surviving spouse may use the predeceased spousal carryover amount in addition to his or her own $5 million exclusion for taxable transfers made during life or at death (§ 2010(c)).

Example. H and W are husband and wife. H dies in 2011 and uses $3,000,000 of his $5,000,000 exemption to eliminate his estate. As a result, $2,000,000 of his exemption is unused. In 2012, W dies. W’s exemption amount is $7,000,000 (her $5,000,000 + the unused amount of her last deceased husband of $2,000,000). In effect, the couple is able to exempt up to $10 million from estate taxes ($3,000,000 when H died and $7,000,000 when W died).

If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by such surviving spouse is limited to the lesser of $5 million or the unused exclusion of the last such deceased spouse.

Example. H and W are married. H dies and his unused exclusion is $5,000,000. W remarried NH, a new husband. NH died and his unused exclusion is $2,000,000. By what amount can W increase her exemption? She can use only the unused amount of her last spouse, $2,000,000 (and not the $5,000,000 of her first spouse). Perhaps W should consider this when she remarries.

The unused exclusion amount is available to a surviving spouse only if the executor of the estate of the deceased spouse files an estate tax return on which such amount is computed and makes an election on such return that such amount may be used. The election is irrevocable. The election cannot be made unless that estate tax return is filed on a timely basis as extended. Thus, even if a decedent normally is not required to file an estate tax return, it appears that a return is now necessary simply to preserve the unused exclusion amount.

Page 1-17

Example 16. The result remains the same under the new law. In 2011, the taxpayer could make a taxable gift of up to $5,000,000 and pay no tax.

Unified Credit for Gift Tax. As noted above, the unified credit for the gift tax is not changed for 2010, remaining at $345,800 to exempt $1,000,000 from gifts. However, for 2011 and 2012 it is raised to the equivalent of the credit for the estate tax, $1,730,800 that exempts $5,000,000 of taxable transfers.

Important Note. Although the exemption for both the estate tax and gift tax is $5,000,000 for 2011 and 2012, this does not mean that an individual can gift $5,000,000 during life and avoid gift taxes and then transfer another $5,000,000 at death and avoid estate taxes. An examination of the estate tax formula reveals that the tax base for computing the estate tax is increased by any taxable gifts made during the decedent’s lifetime (i.e., adjusted taxable gifts). By adding this amount (e.g., $5,000,000 of taxable gifts), the effect is to reduce the amount of unified credit that is available at death as shown in the following example.

Example. In 2011 Muzik made taxable gifts (after the annual exclusion) of $5,000,000. In 2012, he died with a taxable estate of $5,000,000. Does Muzik avoid estate and gift taxes on transfers of $10,000,000 ($5,000,000 during life and $5,000,000 at death)? The answer is a resounding “no” as demonstrated below.

Taxable gifts in 2011 $5,000,000

Gift tax ($155,800 + $1,575,000 [35% x ($5,000,000 - $500,000 = $4,500,000)] 1,730,800

Unified credit (1,730,800)

Gift tax $ 0

In 2012, Muzik died. His taxable estate was $5,000,000. His only taxable gifts during his life were $5,000,000 in 2011. What is the amount of estate tax, if any, that must be paid?

Taxable estate at death in 2012 $5,000,000

Taxable gifts in 2011 5,000,000

Total taxable transfers $10,000,000

Gross tax

Tax on $500,000 $ 155,800

Tax on remainder $9,500,000 (35% x ($10,000,000 - $500,000 = $9,500,000)) 3,325,000

Total $3,480,800

Unified credit for estate tax purposes ( 1,730,800)

Estate tax $1,750,000

The amount of the estate tax is $1,750,000 as computed above.

Muzik pays no gift taxes in 2011 due to the unified credit of $1,730,800. The credit effectively exempts $5,000,000 of taxable gifts from tax. When Muzik dies, it appears that the estate is allowed to use the full amount of the unified credit, $1,730,800 again (or the full amount of the exemption $5,000,000 again). However, looks can be deceiving. The addition of the taxable gifts of $5,000,000 to the taxable estate effectively produces additional tax of $1,750,000 or 35% of the additional $5,000,000. So instead of sheltering $10,000,000 as it might seem, the unified credit only shelters $5,000,000. Also observe that the estate tax is 35% of the amount of the taxable estate in excess of $5,000,000 or $1,750,000 [35% x ($10,000,000 - $5,000,000 = $5,000,000)]. The addition of the previous taxable gifts essentially creates additional tax ($1,730,800) that eliminates the entire unified credit for use against the estate tax.

Example. The result remains for 2010. Unfortunately, had the taxpayer made the 2010 gift of $2,000,000 in 2011, there would be no gift tax since the unified credit for gift tax purposes increases to $1,730,800 to shelter cumulative taxable gifts of $5,000,000.

Page 1-18

Portability of the Unused Unified Credit for Gift Tax (§ 2010(c)). As noted above, the 2010 Act introduced the so-called portability rule. According to this rule, any credit (exemption) that remains unused as of the death of a spouse who dies after 2010 (the “deceased spousal unused exclusion amount”) is portable; that is, the unused amount is generally available for use by the surviving spouse, as an addition to the surviving spouse's exemption. This rule applies for both the estate tax and gift tax. For example, assume H and W are married. H dies in 2011 and uses $3,000,000 of his $5,000,000 exemption to eliminate his estate. As a result, $2,000,000 of his exemption is unused. In 2012, W makes a taxable gift of $6,000,000. W pays no gift tax due to her $5,000,000 as increased by the $2,000,000 unused exemption of her deceased husband. After the gift, W has $1,000,000 of unused exemption remaining ($5,000,000 + deceased husband’s unused exemption $2,000,000 – taxable gift $6,000,000).

Decedents Dying in 2010. (Note: the explanation contained below requires knowledge of advanced concepts).

A special option exists for individuals that die in 2010. This option applies only for 2010. Under the Act, estates of decedents dying in 2010 may choose between (1) paying the estate tax, if any (based on a $5 million exemption and 35% top rate) and a basis equal to the property’s fair market value at death, or (2) paying no estate tax and using the decedent’s basis as the basis of the property (i.e., a modified carryover basis under § 1022). If the estate does nothing, it will be subject to the estate tax and the basis of the decedent’s property will be FMV. This is the default provision. If the estate wants to pay no estate taxes (and use the carryover basis rules), the estate must elect not to pay the required tax. For a decedent dying after 2009 and before December 17, 2010, the due date of the return or election is no earlier than September 17, 2011 (the date that's nine months after the December 17, 2010 enactment date).

Example. R, a single individual, dies in 2010 with an estate worth $6.5 million and with a basis of $4.5 million. Under the 2010 Act, the estate tax before the credit would be $2,255,800 [$155,800 + $2,100,000 (35% x ($6,500,000 - $500,000 = $6,000,000))] and $525,000 after the credit. Thus the heirs must pay a tax of $525,000 to get a step-up in basis to $6.5 million in the assets. If the executor were to make the election, the estate would owe no estate tax and his heirs would have a basis of $4.5 million. Assume that after holding the assets for more than one year, the heirs sell the assets for their value of $6.5 million. Assume further that the assets were capital assets and the gain on the sale would be taxed at a 15 percent rate. In such case, the heirs would pay an income tax of $300,000 (15% rate x $2 million gain ($6.5 million - $4.5 million original basis ) Thus, in this case, the election should be made as it would result in lower combined estate and income tax ($300,000 as opposed to $525,000). Moreover, the income tax is only paid if the heirs sell the assets. Therefore, the tax can be deferred.

Generation Skipping Transfer Tax. Although not discussed in the text, the third leg of the transfer tax regime is the generation skipping transfer tax (GST tax). The GST tax was created in 1976 to ensure that a transfer tax was paid by every generation. Absent this tax, individuals could make transfers that skipped generations and therefore avoid transfer tax on the intervening or skipped generation. To illustrate, assume grandfather dies survived by his son and his granddaughter. If grandfather leaves $10 million to his granddaughter who later dies with the $10 million, both the grandfather and granddaughter would be subject to the estate tax but there would be no transfer tax on the son’s generation. The GST tax plugs this hole and would be triggered in this situation.

The GST tax expired in 2010 along with the estate tax. However, the Act reinstates the generation-skipping transfer tax for transfers made after 2010. For generation-skipping transfers made during 2010, the tax rate is zero.

Page 1-20

Employment Taxes

Social Security Wage Base for 2011. The wage base for social security for 2011 remains the same at $106,800.

Temporary Employee and Self-Employed Payroll Tax Cut for 2011. For 2011, the Act reduces the social security tax rate for employees under the FICA tax by two percentage points from 6.2% to 4.2%. As a result, for 2011, employees will pay only 4.2% Social Security tax on wages up to $106,800. Thus, the combined rate on the first $106,800 is cut from 7.65% to 5.65% (4.2% + 1.45%) but remains 1.45% on each dollar over $106,800. The maximum tax is savings for 2011 will be $2,136 (2% of $106,800) per taxpayer. If both spouses earn at least as much as the wage base, the maximum savings would be twice that amount or $4,272. While this change is a true benefit for most working Americans, it does not provide any relief for those who do not pay into the Social Security system (e.g., some public employees).

The employer’s share of the Social Security tax is not reduced so employers must continue to pay 6.2% on up to $106,800. Thus, the employer does not “match” the employee’s contribution for the first $106,800 for 2011 but pays 2 percentage points more on the first $106,800.

Example 21. Under the new law for 2011, the total employment taxes would be $7,966 computed as follows:

Social security portion = 4.2% x $106,800 $4,486

Plus: MHI portion = 1.45% x $240,000 + 3,480

Total FICA taxes $7,966

Note that the reduction under the Act is $2,136 ($10,102 - $7,966) or 2% of the wage base up to $106,800 (2% x $106,800 = $2,136).

Page 1-22

Example 22. During 2011 E earned $100,000 from his regular job and $50,000 from a part-time job for a total of $150,000. E’s full time employer withheld $5,650 ($100,000 x 5.65%) and E’s part time employer withheld $2,825 ($50,000 x 5.65%). Each employer paid their contributions (7.65%) and paid the withheld amount to the IRS. E has paid a total FICA taxes of $8,475 (($100,000 x 5.65% = $5,650) + ($50,000 x 5.65% = $2,825). The maximum amount of social security that an individual must pay is limited to 4.2% on wages of up to $106,800. Thus E’s total employment tax (using the new rates for 2011) should be $6,660 [($106,800 x 4.2% = $4,485) + ($150,000 x 1.45% = $2,175)]. Thus E will be entitled to a tax credit or refund of the $1,815, the difference between the amount paid of $8,475 and the amount due of $6,660. Note that this simply represents the 4.2% FICA taxes withheld on E’s wages in excess of the $106,800 [4.2% x ($150,000 - $106,800 = $43,200) = $1,815]

Self-Employed Taxpayers. The 2010 Act reduces the FICA rate for both employees as well as self-employed taxpayers. The FICA rate for self-employed persons of 12.4% is reduced by 2 percentage points to 10.4%, resulting in a total rate of 13.3% (10.4% + 2.9%). (Note: the self-employment tax rate for social security is normally viewed as twice the employee’s rate or 2 x 6.2% or 12.4%. This same view does not hold under the new law. Technically, the individual is employing himself and pays the 4.2% employee share and then the employer’s share of 6.2% is not changed. Thus the rate is 10.4% (and not 8.4% as some might think).)

Page 1-22

Calculation of the Self-Employment Tax for 2011. The actual calculation of the tax remains the same for 2011 (other than the new rate). There is no modification in determining the self-employment tax base by one-half of the 15.3 percent tax or 7.65 percent as illustrated in Examples 23 and 24. Thus the base continues to be 93.75% of net earnings from self-employment.

Deduction of Self-Employment Tax for AGI (§ 164(f)). The income tax deduction for self-employment taxes for 2011 is revised and no longer is one-half of the self-employment tax. The deduction is made up of two components: 59.6% of the Social Security tax paid, plus 50% of the Medicare tax paid. In other words, for one year, the new percentage (59.6%) replaces the rate of one half (50%) allowed before enactment of the 2010 Act but only for the Social Security portion. The new percentage is required to continue to allow self-employed taxpayers to deduct the full amount of the employer portion of the self employment tax. Under prior law, the employer’s share of the Social Security tax was 50% (6.2%/(6.2% + 6.2% =12.4%)). Under the new law, the employer’s portion represents a greater share of the total Social Security tax or 59.6% (6.2%/(6.2% + 4.2% = 10.4%)). Thus, the total deduction for self-employment tax for AGI is determined as follows:

59.6% x Social Security tax (the 10.4% portion)

+ 50.0% x MHI tax (the 2.9% portion)

Deduction for Self-Employment tax for AGI

These calculations are illustrated in Example 24 below.

Example 23. No changes are necessary.

Page 1-23

Example 24. Individuals C and D have net earnings from self-employment for 2010 of $50,000 and $150,000, respectively. Self-employment taxes for C and D are determined as follows:

Self-employment tax computation C D

Social Security (10.4% portion)

Net earnings from self-employment $50,000 $150,000

- (1/2 x 15.3% = 7.65%) of net earnings ( 3,825 ) ( 11,475 )

SE tax base (92.35% net earnings)* $46,175 $138,525

Smaller of SE tax base above or

maximum wage base ($106,800 for 2011) $46,175 $106,800

x x 10.4% x 10.4 % x 10.4 %

Social Security tax $4,802 $11,107

MHI (2.9% portion)

Net earnings from self-employment $50,000 $150,000

- (1/2 x 15.3% = 7.65%) of net earnings ( 3,825 ) ( 11,475 )

SE tax base (92.35% net earnings)* $46,175 $138,525

x 2.9% x 2.9 % x 2.9 %

MHI tax 1,339 4,017

Total self-employment tax $6,141 $15,124

Deduction for Social Security tax

Social security tax $4,802 $11,107

x 59.6% x 59.6 % x 59.6 %

Deduction for social security tax $2,863 $6,620

Deduction for MHI tax

MHI tax $1,339 $4,017

x 50% x 50.0 % x 50.0 %

Deduction for MHI tax 670 2,009

Total deduction for self-employment taxes $3,533 $8,629

* Not to exceed wage base – wages received

**No reduction for wages.

C will be allowed to deduct $3,533 (for income tax purposes, and D will be allowed to deduct $8,629. Note that these deduction amounts are the same as in the original example since the “employers” share of self-employment tax did not change. At the same time, observe that these amounts are not 50% of the total self-employment tax, which would have been $3,070 (50% x $6,141) and $7,562 (50% x $15,124) respectively.

Page 1-24

Example 25. The calculations change due to the cut in the self-employment tax rate on the social security by 2 percentage points from 12.4% to 10.4%.

Smaller of reduced maximum tax base or amount determined above $18,800

Times: Social security tax rate x 10.4 %

Tax on social security component $ 1,955

Social security tax . $ 1,955

Plus: MHI tax ($46,175 _ 2.9%) . 1,339

Equals: T’s self-employment tax . $ 3,294

T may claim an income tax deduction for A.G.I. for the self-employment taxes of $1,835 [(59.6% x $1,955 = $1,165) + (50% x $1,339 = $670)]

FICA Tax Holiday. As part of the Hiring Incentive to Restore Employment Act signed into law on March 18, 2010, employers who hired individuals who were formerly unemployed were not required to pay the employer share of Social Security taxes on their wages (the 6.2% portion). In addition, the employer could also claim a credit of up to $1,000 for retaining each of these workers for at least one year.

FICA tax forgiveness began on March 19, 2010 for “qualified employers” who hired a “qualified individual” after February 3rd, 2010 and before January 1st, 2011. For this purpose, a qualified employer generally is defined as any employer other than the government. A qualified individual normally is defined as someone who certifies by signed affidavit, under penalties of perjury, that he or she has not been employed for more than 40 hours during the 60-day period ending on the date such individual begins such employment. In addition, a qualified individual cannot be employed by the qualified employer to replace another employee of such employer unless such other employee separated from employment voluntarily or for cause.   An explanation provided by the Joint Committee on Taxation states that rehiring laid-off workers or filling positions of laid-off workers with new workers is permitted. Lastly, a qualified individual cannot be a relative of the employer as defined in IRC § 51(i).

The “FICA tax holiday” for employers expired as scheduled after 2010.

Medicare Tax Increase in 2013. To help pay for the cost of the Health Care Act, the Act provides for an increase in the Medicare tax in 2013 on employees (i.e., but not on employers). The increase will be .9% on wages in excess of $200,000 for individuals and $250,000 for joint filers (i.e., the rate increases from 1.45% to 2.35%). The additional MHI tax means that the portion of wages received in connection with “employment” in excess of $200,000 ($250,000 for joint filers) will, after the effective date, be subject to a total Medicare tax rate (combined employer and employee portions) of 3.8 percent (i.e., 1.45% by the employer, and (1.45% + .9%) by the employee). A similar increase would apply to self-employed persons.

In a dramatic extension of the Medicare tax, an additional 3.8% tax would be imposed on investment income but only to the extent it exceeded $200,000 ($250,000 for joint filers). For this purpose, the new Medicare tax would be imposed on the lesser of: (1) net investment income from interest, dividends, annuities, royalties, rents and certain other income and gains not generated in the ordinary course of an active trade or business, or (2) modified AGI. This change is estimated to generate $210 billion to help fund the health care plan.

Tax on Cadillac Health Care Plans in 2018. The Health Care Act imposes a 40% surtax on “high-cost” –Cadillac—health care plans beginning in 2018. Generally, the tax applies if the annual premium payments exceed an inflation-adjusted $10,200 for individual coverage and $27,500 for family coverage. Although the effective date is seven years away, this tax has already been the subject of debate and will no doubt be the subject of greater debate in the next few years.

CHAPTER 2: TAX PRACTICE AND RESEARCH

Page 2-3

Tax Return Preparers. After an extensive review that included significant public input, the IRS made fundamental changes in how it regulates the tax return preparation industry. In 2010, the IRS began implementing new regulations and procedures that it believes better serves taxpayers, tax administration and the tax professional industry (see § 6019 and Reg. § 1.6019-2). The new requirements became effective on January 1, 2011, and include: mandatory preparer tax identification numbers (PTINs), continuing education, competency testing, ethical standards and electronic filing. Those who meet all of the requirements are designated as “Registered Tax Return Preparers.” These individuals will be limited to preparing individual income tax returns. The IRS plans to issue additional guidance for those preparing other tax returns.

PTIN Requirements. All tax return preparers who are compensated for preparing, or assisting in the preparation of, all or substantially all of a federal tax return after December 31, 2010 must be registered and have a PTIN. The preparer’s PTIN must be disclosed on the return. Prior to the new rules, preparers could use either their social security number or their PTIN but this option no longer exists. Only the PTIN can be use.

The PTIN requirement applies to virtually anyone who prepares or assists in the preparation of a return. The rule extends to attorneys, certified public accountants, and enrolled agents who are compensated for preparing returns. Note that the IRS has indicated that students who have internships with accounting firms and who prepare returns, regardless of their simplicity, must have a PTIN. In contrast, individuals who volunteer and prepare returns as part of the IRS’ VITA program (voluntary income tax assistance program) need not have PTINs.

Preparers can obtain a PTIN, using an online sign-up system available through taxpros. An annual fee of $64.25 is charged. All applicants must be at least 18 years old.

Competency Testing. Beginning in 2011, tax return preparers normally must pass a competency test to become a registered tax return preparer. For now there are two tests. The tests generally cover the Form 1040 series returns, Schedules, C, E and F and other 1040 related forms. The IRS plans to add an additional test that covers business returns at a future date.

Tax return preparers, who have PTINs before testing becomes available, have until December 31, 2013 to pass the competency test. After testing becomes available, new tax return preparers will be required to pass the competency test before they can obtain a PTIN. Attorneys, certified public accountants, and enrolled agents are exempt from the competency test requirement. Enrolled actuaries and enrolled retirement plan agents are exempt from the competency test requirement if they only prepare returns within the limited practice areas of these groups.

Continuing Education. In addition to passing a competency test, preparers are subject to a continuing education requirement of 15 hours per year. As of this writing, the start date for the education requirement has not been determined. Courses must include 3 hours of federal tax law updates, 2 hours of ethics, and 10 hours of other federal tax law. The education requirement does not apply to attorneys, certified public accountants, enrolled agents, enrolled actuaries, or enrolled retirement plan agents since all of these are already subject to education requirements to maintain their credentials.

E-Filing. The Worker, Homeownership, and Business Assistance Act of 2009 provided that after 2010, tax return preparers who expect to file more than 10 individual, estate, or trust returns must file them electronically. However, the IRS subsequently announced a phase-in of this new e-filing requirement. At this writing, return preparers must file electronically in 2011 only if they anticipate filing 100 or more returns. States have their own rules regarding e-filing.

Almost 99 million individuals filed their tax returns electronically during 2010, a 3% increase over 2009. During the past decade, the percentage of returns e-filed each year has risen steadily from 30.73% in 2001 (40,244,000 of 130,965,000 total returns) to 69.76% in 2010 (98,740,000 of 141.536,000 total returns). The IRS has made the observation that “e-filing is no longer the exception, it is instead the norm." Taxpayers who prepare their own tax returns on their home computers accounted for more than 35% of e-filers.

Reliance on Tax Preparation Software No Excuse for Return Errors. As may be recalled, at his confirmation hearings, current Treasury Secretary Timothy Geitner implied that the mistakes in his tax returns were caused by the use of TurboTax tax software program. A recent case addresses this possibility. In Phu M. Au, TC Memo 2010-247, 11/10/2010, the court made it clear that reliance on software was no excuse for errors. In this situation, the taxpayers prepared their 2006 federal tax return using H&R Block's TaxCut software. Not understanding the tax law well enough, they reported AGI of $83,041, listing gambling losses of $40,488 against no gambling winnings. Under the law, gambling losses are only deductible to the extent of gambling winnings. The winnings are reported as “other income” on page 1 of Form 1040 while gambling losses are deductible only as itemized deductions (not subject to the 2% of AGI limitation). The Tax Court not only disallowed the deduction but also upheld the Code § 6662 20% accuracy-related penalty. The penalty was imposed despite taxpayers' contention that they followed the instructions for using the software (which they claimed was "approved by the IRS"). The court doubted that "the instructions, if correctly followed, permitted a result contrary to the express language of the Code.” It concluded that . “[The taxpayers] may have acted in good faith but made a mistake. In the absence of evidence of a mistake in the instructions or a more thorough effort by [the taxpayers] to determine their correct tax liability, we cannot conclude that they have shown reasonable cause for the underpayment of tax."

Page 2-34

Form 1099 Reporting Changes in 2012. One of the most controversial provisions contained in all of the tax legislation in 2010 was a little discussed provision in the Health Care Act regarding information reporting. In 2012, every person engaged in a trade or business (including employees and those who are self-employed) who makes payments aggregating $600 or more during the year to another person for goods or services in the ordinary course of the payor’s business must issue a Form 1099 to that party. The Health Care Act’s mandate aims to collect lost revenue from companies that under-report on their tax returns. The provision is expected to raise $17 billion per year over 10 years or $170 billion!

The basic rule requiring 1099 reporting for payments for services is well-known. However, the Health Care Act made two important changes. First, it added payments for property or goods to the list of payments subject to reporting—not just services. In addition, it provided that payments to a corporation (that are not tax-exempt), which had previously been exempt from the reporting requirement, would be subject to the rule.

As might be expected, many have raised concerns about the burden the new rules may impose. Indeed, the 1099 requirement has the distinction of being the first provision of the health care bill to be challenged in Congress. Congressman Daniel Lungren (R-CA) introduced legislation on April 26, 2010 to repeal the rule. Lungren said that small businesses do not have the resources to comply with the reporting requirement, and called the provision a "rat tax" because it requires companies to report on the companies they do business with.

However, the provision seems to be weathering the storm. Attempts to repeal the measure have failed thus far. An attempt in the House to repeal the bill last July failed. The Senate failed to pass legislation in November. Another try in December also failed.

To help allay these concerns, the IRS has reported that it will exempt from the new requirement business transactions conducted using credit and debt cards and similar payment cards.

Example. T, a graphics designer, is an independent contractor. He has clients all over the country. During the year, he purchased a new iMac computer from the Apple Store for $1,600. In addition, he purchases supplies from Office Max, Staples and Office Depot. To see some of his clients, he flies on various airlines, including Delta, Southwest and United. Because the payments to Apple for goods purchased during the year exceed $600, the new rule requires T to send Apple a 1099. T would need to keep track of his purchases at the office supplies stores and the airlines to determine if the aggregate purchases from any one company exceeded $600. In order to file the 1099 for his purchase at Apple ( one to Apple, one to the IRS, and a copy for him), T would need to obtain Apple’s Taxpayer Identification Number. Apparently, if he charged it on his credit card, future regulations would exempt him from reporting.

Tax Gap and Form 1099 Reporting. In recent testimony before the Senate Committee on Small Business and Entrepreneurship, the GAO presented an analysis of issues surrounding the subject of information reporting. According to GAO, third parties, often businesses, reported more than $6 trillion in miscellaneous income payments to the IRS in tax year 2006 on Form 1099-MISC, which the payees were then required to report on their tax returns. The GAO observed that “it is common knowledge that if these payments are not reported on 1099-MISCs, it is less likely that they will be reported on payee tax returns.” In 2010, the reporting requirements were expanded to cover payments for goods (i.e., in addition to services), as well as any payments to corporations, which had both been previously exempt, beginning in 2012. "Information reporting is a powerful tool for encouraging voluntary compliance by payees and helping IRS detect underreported income," the GAO stated, adding that it may also sometimes reduce taxpayers' costs of preparing their tax returns. Meanwhile, the IRS has estimated that $68 billion of the annual $345 billion gross tax gap for 2001 was caused by sole proprietors underreporting their net business income, which GAO largely attributed to the facts that "sole proprietors were not subject to tax withholding and only a portion of their net business income was reported to IRS by third parties." The benefits from information reporting are affected by payors' compliance with reporting requirements and the IRS's ability to match the third-party data with payees' tax returns. However, the IRS does not have estimates of the number or characteristics of payors that fail to submit 1099-MISC. The GAO further noted that payors encounter various difficulties preparing and submitting 1099-MISC, including “complex rules and an inconvenient submission process.”

CHAPTER 3: TAXABLE ENTITIES, TAX FORMULA,

INTRODUCTION TO PROPERTY TRANSACTIONS

Page 3-4

Foreign Earned Income Exclusion. The foreign earned income exclusion for 2011 as adjusted for inflation is $92,900 (§ 911(b)(2)(d)).

Page 3-19 and 3-21

Standard Deduction. One of the major changes made in 2001 by EGTRRA was to address the marriage tax penalty. That principle was applied in various provisions throughout the law, including the provisions for the standard deduction. Under the 2010 Act, the standard deduction for married taxpayers filing jointly (and qualified surviving spouses) remains at 200% of the standard deduction for single taxpayers for two additional years, through 2012.

The basic standard deduction for 2011 (reflecting inflation adjustments) will be:

Joint return or surviving spouse $11,600 (up from $11,400 for 2010)

Single (other than head of household or surviving spouse) 5,800 (up from $5,700 for 2010)

Head of household 8,500 (up from $8,400 for 2010)

Married filing separate returns 5,800 (up from $5,700 for 2010)

Additional standard deduction

Married taxpayers age 65 or blind 1,150 (up from $1,100 for 2010)

Single or head of household age 65 or blind 1,450 (up from $1,400 for 2010)

Individual who can be claimed as dependent on another’s return 950 (same for 2010)

Page 3-21

Additional Standard Deduction. For 2011, the additional standard deduction for married taxpayers 65 or over or blind will be $1,150 (up from $1,100 for 2010). For a single taxpayer or head of household who is 65 or over or blind the additional standard deduction for 2011 will be $1,450 (up from $1,400 for 2010).

Page 3-22

Additional Standard Deduction for Real Property Taxes. This provision expired at the close of 2009 and was not extended.

Page 3-22

Additional Standard Deduction for Disaster Losses. This provision expired at the close of 2009 and was not extended.

Page 3-23

Phase-out of Itemized Deductions. A phase-out of itemized deductions—not discussed in the text—expired in 2010 and was scheduled to return in 2011 but under the Act returns in 2013. Under the cutback or phase-out rule, total itemized deductions generally were reduced by 3% of the excess of the taxpayer’s AGI over a certain threshold ($169,100 had the rule been in effect for 2011). However, this provision was postponed and is now scheduled to return again in 2013. Consequently, the 3%-phase-out of itemized deductions does not apply for 2010, 2011 or 2012.

Page 3-25

Phase-out of Exemptions. A phase-out of exemptions—not discussed in the text—expired in 2010 and was scheduled to return in 2011 but under the Act returns in 2013. Under the phase-out rule, a taxpayer’s total exemption deduction was reduced 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeded the applicable threshold (in 2011 the thresholds would have been $169,550 for unmarried individuals; $254,350 for married couples filing joint returns; $211,950 for heads of household). However, this provision was postponed and is now scheduled to return again in 2013. Consequently, the phase-out of the exemption deduction does not apply for 2010, 2011 or 2012.

Page 3-25

Taxable Income and Tax Rates. The tax rates for 2011 (as adjusted for inflation) can be found at the beginning of this supplement under “INSIDE FRONT COVER.” In 2011, the 28% marginal rate applies to single taxpayers when taxable income exceeds $83,600 and $139,350 for joint filers.

Page 3-27

Alternative Minimum Tax. The 2010 Act increases the exemption amounts for the alternative minimum tax for 2010 and 2011 as follows:

Alternative Minimum Tax Exemption Amounts

2009 2010 2011

Unmarried taxpayer (not surviving spouse) $46,700 $47,450 $48,450

Joint filers including surviving spouses 70,950 72,450 74,450

Married individuals filing separate returns 35,475 36,225 37,225

Estates and trusts 22,500 22,500 22,500

Page 3-33

In the last paragraph, the personal casualty loss floor is $100 for losses after 2009.

Page 3-33

Prior to the enactment of EGTRRA in 2001, the maximum rate of tax on an individual's long-term capital gain was generally 20%. This rate was schedule to return but was postponed. For 2010, 2011 and 2012, the tax rates remain at 15% (0% for taxpayers otherwise in the 15% or 10% brackets).

Page 3-36

Qualified Dividends. The Act continues to tax qualified dividends at a maximum rate of 15% (0% if the taxpayer is in the 15% or 10% bracket) through 2011 and 2012.

CHAPTER 4: PERSONAL AND DEPENDENCY EXEMPTIONS;

FILING STATUS, DETERMINATION OF TAX, ETC.

Page 4-2

The personal exemption for 2011 is $3,700 (as adjusted for inflation).

Phase-out of Exemptions. A phase-out of exemptions—not discussed in the text—expired in 2010 and was scheduled to return in 2011. However, under the Act its return was postponed. Barring any future action, the phase-out will once again apply in 2013. Under the phase-out rule, a taxpayer’s total exemption deduction was reduced 2% for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeded the applicable threshold (in 2011 the thresholds would have been $169,550 for unmarried individuals; $254,350 for married couples filing joint returns; $211,950 for heads of household). However, this provision was postponed and is now scheduled to return again in 2013. Consequently, the phase-out of the exemption deduction does not apply for 2010, 2011 or 2012.

Page 4-13

Child Tax Credit. The child tax credit was scheduled to drop to $500 in 2011 and the credit was not to be allowed against the alternative minimum tax. However, these changes were postponed for two additional years. The credit will continue to be $1,000 for 2010, 2011 and 2012. Similarly, the credit will be available to offset the AMT.

Page 4-28

Personal exemption. The exemption is $3,700 for 2011.

Standard deduction . The standard deduction for an individual who can be claimed as a dependent on another’s return for 2011 remains at $950.

Kiddie tax. The threshold at which unearned income becomes subject to the kiddie tax continues to be $1,900 for 2011.

CHAPTER 6: INCLUSIONS AND EXCLUSIONS

Page 6-4

Qualified Dividends. The favorable 15% and 0% tax rates for qualified dividends were schedule to expire at the close of 2010. At that point, dividend income would be treated and taxed as ordinary income as it was before EGTRRA of 2001. Without the Tax Relief Act, the rate would have been as high as 39.6%. The Act extends the preferential rates for 2011 and 2012.

The continuation of the 0% bracket will be especially important for taxpayers such as retirees who live off their dividend and capital gain income. To the extent that they are able to keep their taxable income below $68,000 (for joint filers in 2010 and $69,000 in 2011), they will have this special 0% rate for both LTCGs and dividends.

Page 6-24

Unemployment Benefits. The Act secured an extension of unemployment benefits for an additional 13 months. According to the administration, without this extension, two million unemployed individuals would have lost their benefits in December 2011 and another seven million in 2011. Although unemployment benefits are normally taxable, a temporary exception was created for 2009 that allowed the exclusion of up to $2,400 in benefits. This exception applies only for 2009 and was not reinstated or extended for future years. (See § 85(c).)

Page 6-30

Adoption Assistance Programs. The Health Care Act increased the exclusion for adoption for 2010 to $13,170.

Educational Assistance Plans. The rules governing educational assistance plans were scheduled to revert to pre- EGTRRA law. The Act extends the current rules for 2010 and 2011.

Page 6-34

Employer Provided Transportation Benefits. The 2010 Act makes changes to ensure that these benefits would continue at their current levels through 2011. For 2011, the exclusion remains at $230 as adjusted for inflation.

CHAPTER 7: OVERVIEW OF DEDUCTIONS AND LOSSES

Page 7-8

Start-up Expenses. The Small Business Jobs Act of 2010 signed into law by the President on September 27, 2010 increased the amount of start-up costs that may be expensed in 2010 from $5,000 to $10,000. This is only for expense incurred in 2010.

Page 7-25

Employee or Independent Contractor. A recent case indicates the controversies that can arise in determining whether a worker is an employee or independent contractor. In Cheryl Mayfield Therapy Center, TC Memo 2010-239 (10/28/10) the taxpayer owned and operated a spa where she provided space for massage therapists, cosmetologists, and nail technicians who paid the taxpayer a weekly "booth rent" equal to the greater of a base rent amount or 25% of the service provider's gross revenue. After weighing the factors outlined in Rev. Rul. 87-41, the Tax Court agreed with the taxpayer's treatment of the service providers as independent contractors. The specific factors weighing in the taxpayer's favor included: (1) the minimum rent arrangement charged to the service providers, (2) the lack of reimbursement for service providers' business or travel expenses, (3) service providers made their own investments in the therapy rooms, and (4) service providers could refuse clients or opt out of suggested spa pricing.

Page 7-33

Environmental Remediation Costs. The Act extends the expensing provision under § 198 for two years through 2011.

CHAPTER 8: EMPLOYEE BUSINESS EXPENSES

Page 8-5

Deduction for Qualified Tuition. The Act extends the deduction for higher education expenses to 2010 and 2011.

Page 8-8

Teacher’s Out of Pocket Expenses. The deduction for expenses of primary and secondary school teachers is extended so it is now available in 2010 and 2011.

Page 8-26

Standard Mileage Rate. For 2011, the rate is 51 cents per mile (up from 50 cents per mile in 2010 and down from 55 cents per mile in 2009).

CHAPTER 9: CAPITAL RECOVERY: DEPRECIATION, AMORTIZATION

AND DEPLETION

Page 9-10

Qualified Leasehold and Retail Improvements and Restaurant Property. Prior to the Act, qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property that was placed in service before 2010 was considered 15-year property for depreciation purposes. Thus, the rule did not apply for 2010 and beyond. The Act retroactively extends for two years the inclusion of this property placed in service on or before December 31, 2011 in the 15-year MACRS class [see § 168(e)(3)(E) and § 168(e)(8)(E)].

Motorsports Entertainment Complexes. Real estate improvement and support facilities at motorsports entertainment complexes placed in service before 2010 could be depreciated over a 7-year life. Thus the rule did not apply for 2010 and beyond. The Act retroactively extends the 7-year straight line cost recovery period for motorsports entertainment complexes for two years through 2011(see § 168(i)(15)(D)).

Costs of Film and TV Production. Taxpayers may elect to expense up to $15 million of production costs of qualified film and television (TV) productions but only if they are produced in the U.S. The limit is $20 million if production expenses were “significantly incurred” in certain low-income communities or isolated areas of distress. These rules expired in 2009. The 2010 Act retroactively extends the expensing provision for two years through 2011 (see § 181(f)).

Page 9-26

Bonus Depreciation

One of the most important changes made by the Tax Relief Act concerns depreciation. To encourage businesses to invest in new machinery and equipment, the new rules provide significant incentives. After consideration of changes by the Jobs Act and the Tax Relief Act, the amount of additional first year depreciation (bonus depreciation) depends on when the qualified property is placed in service. If the property was placed between January 1, 2008 and September 8, 2010 (inclusive), the deduction for depreciation is equal to 50% of the adjusted basis of new qualified property (§ 168(k)). For property placed in service after September 8, 2010 and before January 1, 2012 (and January 1, 2013 for certain longer-lived and transportation property), 100 percent of the cost of qualified property can be deducted. There is no cap on the amount of the deduction. Thus, if a business purchases qualified property for $10,000, $100,000, $1,000,000, $10,000,000 or whatever the amount during the magic period, it will be able to write-off the entire cost of the property! Observe that because there is no limitation on the deduction, bonus depreciation could create or increase a net operating loss and generate immediate cash flow

.

This “bonus” depreciation is in addition to any amount expensed under § 179 and regular depreciation. Of course, § 179 and regular depreciation would only apply in those situations where the 100 percent write-off rule does not apply. (e.g., before September 8, 2010 and after December 31, 2011). Note that property may be expensed under § 179 whether it is bought new or used. By contrast, property is eligible for the new 100% first-year write-off only if it is new.

Page 9-24

Section 179 Limited Expensing.

Expense Amount. Congress continues to tinker with § 179. The Small Business Jobs Act of 2010 increased the maximum amount of qualifying property that can be expensed under § 179. For 2010 and 2011, the amount that can be expensed is $500,000, reduced to the extent the amount of total investment in qualifying property exceeds $2,000,000. Thus, the § 179 deduction phases out completely when the cost of the property exceeds $2,500,000.

Absent further changes, the § 179 amount would drop to $25,000 in 2012. However, for tax years beginning in 2012, the 2010 Tax Relief Act increases the maximum expensing amount from $25,000 to $125,000 and increases the investment-based phaseout amount from $200,000 to $500,000. The $125,000/$500,000 amounts will be indexed for inflation. However, for tax years beginning after 2012, the maximum expensing amount drops to $25,000 and the investment-based phaseout amount drops to $200,000.

Page 9-28

Limitations on Automobiles (Exhibit 9-11). The Small Business Act of 2010 increases the first year limitation on deductions for automobiles. The deduction limitations for passenger automobiles placed in service in 2010 prior to the increase by the 2010 Act for the first three years are $3,060, $4,900, $2,950 and $1,775 for each succeeding year. For trucks and vans, the 2010 limitations for the first three years are $3,160, $5,100, $3,050, and $1,875 for each succeeding year. Under the Jobs Act, the first year limitation is increased for vehicles placed in service before 2011 by $8,000. Thus the limit for passenger automobiles for 2010 is $11,060 ($8,000 + $3,060) for the first year and unchanged for the remaining years. For trucks and vans, the limitation for 2010 is $11,160 ($8,000 + $3,160) and unchanged for the remaining years.

The Tax Relief Act extends these rules so the $8,000 increase will also be allowed in 2011 and 2012.

Page 9-34

Cell Phones. The Jobs Act makes it clear that cell phones and similar telecommunications equipment are not listed property (§ 280F(d)(4)). As a result, employees no longer have to meet the convenience of the employer or condition of employment tests in order to qualify for a deduction. More importantly, the strict substantiation requirements and limitations on depreciation and § 179 do not apply. In those cases where an employer provides cell phones to employees, they will qualify as working condition fringe benefits. According to the Senate Finance Committee Summary dated July 21, 2010, the Act “delists” cell phones so their cost can be deducted or depreciated like other business costs, without onerous recordkeeping requirements. Thus employers may deduct the cost of providing cell phones to their employees for employment-related business use, without having to satisfy the strict substantiation requirements for listed property. To support a deduction for the cell phones, the employer need only substantiate their cost, in much the same way as the employer supports the deduction for other types of business equipment

CHAPTER 10: CERTAIN BUSINESS DEDUCTIONS AND LOSSES

Page 10-10

Per Casualty Floor. For tax years beginning after December 31, 2009, the per-casualty floor reverts to $100 (§ 165(h)). Thus the floor is $100 for 2008, $500 for 2009 and $100 for 2010 and years thereafter.

CHAPTER 11: ITEMIZED DEDUCTIONS

Page 11-5

Medical Expense Floor to Increase in 2013. The Health Care Act provides that for tax years beginning after Dec. 31, 2012, unreimbursed medical expenses will be deductible by taxpayers under age 65 (i.e., determined as of the last day of the tax year) only to the extent that these costs exceed 10% of AGI for the tax year (§ 213(a)). If the taxpayer or his or her spouse has reached age 65 before the close of the tax year, the current 7.5% threshold applies through 2016, with the new 10% threshold then applying for tax years ending after Dec. 31, 2016. (Code §213(f))

Page 11-14

Standard Deduction Increase for Property Taxes Repealed. The Housing Assistance Act of 2008 added a new twist to the standard deduction (§ 63(c)(1)(C)), allowing homeowners to increase their standard deduction for a portion of the real property taxes on their home. This provision expired in 2009 and has not been extended.

Page 11-17

State and Local General Sales Tax. Current law allows taxpayers to elect to take an itemized deduction for state and local general sales taxes instead of an itemized deduction for state and local income taxes. The Act extends this rule to 2010 and 2011.

Page 11-26

Qualified Mortgage Insurance. The Act extends this deduction through 2011.

Page 11-29

Student Loan Interest. The Act extends current law for 2011 and 2012. EGTRRA eliminated a 60-month rule (i.e., the deduction was only available for the first five years after loan repayment commenced) for the $2,500 above-the-line student loan interest deduction and expanded the modified AGI range for phaseout. These enhancements were scheduled to expire after December 31, 2010.

Page 11-41

Enhanced Contributions Deduction for Corporations. The special enhanced deduction granted to C corporations for contributions of computer technology, food inventory and book inventory is extended and applies for 2010 and 2011.

Contributions of Real Property for Conservation. To encourage charitable contributions of real property for conservation purposes, special rules apply to donations. Generally, the various limitations that usually apply to donations of real estate are eased for these donations, especially if the contributor is a farmer. The incentives were extended by the Act for 2010 and 2011.

CHAPTER 13: THE ALTERNATIVE MINIMUM TAX AND TAX CREDITS

Page 13-6

AMT Exemptions. To reduce the number of individuals affected by the AMT, the 2010 Act increases the exemption amounts as shown below:

Alternative Minimum Tax. The 2010 Act increases the exemption amounts for the alternative minimum tax for 2010 and 2011 as follows:

Alternative Minimum Tax Exemption Amounts

2009 2010 2011

Unmarried taxpayer (not surviving spouse) $46,700 $47,450 $48,450

Joint filers including surviving spouses 70,950 72,450 74,450

Married individuals filing separate returns 35,475 36,225 37,225

Estates and trusts 22,500 22,500 22,500

These amounts would have dropped significantly without action by Congress. The phase-out rules remain the same.

Nonrefundable Credits and the AMT. Under the Act, the use of nonrefundable credits to reduce the AMT and the regular tax is continued through 2011.

Planning. Although Congress has patched the AMT several times with increased exemption amounts, it has not changed the thresholds at which the exemption begins to phase-out. Because the levels at which the exemptions begin to phase-out are not adjusted for inflation and have remained fixed for many years, more and more persons are subject to the AMT. The phase-out begins at $112,500 (for single and head-of-household filers) and $150,000 (for joint filers). For this reason, individuals must be wary of discretionary sales of investment and other assets which could dramatically increase regular taxable income. Even though LTCGs are taxed at just 15% for both regular tax and AMT purposes, significant increases in this type of income will still push up the “starting point” (i.e., regular taxable income) for calculating the AMT. This, in turn, could cause pre-AMTI to exceed the exemption phase-out thresholds.

Page 13-17

Gain on the Sale of Qualified Small Business Stock

Qualified Small Business Stock Exclusion (§ 1202). This provision, sometimes referred to as the darling of Wall Street, allows investors in eligible businesses to exclude no less than a whopping amount of gain on the sale of eligible stock. Generally, if the stock is held for more than five years, the exclusion is 50 percent of the gain realized. However, recent changes enabled taxpayers to exclude even more. The American Recovery and Reinvestment Act of 2009 increased the exclusion to 75% of the gain for stock acquired after February 17, 2009 and before September 28, 2010, assuming the stock is held for more than five years. . The Small Business Jobs Act of 2010 increased the exclusion. Under the Jobs Act, taxpayers may exclude all of the gain—100 percent—on the disposition of qualified small business stock acquired during a brief window of opportunity: after September 27, 2010 and before January 1, 2011. At that point, the exclusion was scheduled to revert to 50% for stock acquired after December 31, 2010. However, the 2010 Act extends this provision for one year so that taxpayers may continue to exclude 100% of gain from the disposition of qualified small business stock acquired before Jan. 1, 2012! Note that such stock must be held for five years in order to obtain the special treatment.

A portion of the gain is considered a tax preference item subject to the alternative minimum tax. The amount identified as a preference item currently is 7% of the excluded gain and was scheduled to return to the pre-EGTRAA level of 42% in 2011. However, the Act extends the 7% rate through 2011 and 2012.

Page 13-29

New Markets Tax Credit. The 2010 Tax Relief Act retroactively extends the new markets tax credit two years through 2011.

Differential Wage Payment Credit for Employers. Some employers voluntarily agree to continue paying the compensation that service members would otherwise have received had they not left for active duty. This compensation is referred to as differential wages. The Heroes Act created a new tax credit for eligible small business employers that pay differential wages to qualifying employees. The credit is equal to 20% of up to $20,000 of differential pay to each qualifying employee during the tax year. A qualified employee is one who has been an employee for the 91-day period immediately preceding the period for which any differential wage payment is made. An eligible small business employer is one that: (1) employed on average less than 50 employees on business days during the tax year; and (2) under a written plan, provides eligible differential wage payments to each of its qualified employees. The initial provision provided relief only for payments after June 17, 2008 and before 2010. The 2010 Tax Relief Act retroactively extends this credit two years through 2011.

Page 13-34

Work Opportunity Tax Credit. The Act extends the WOTC four months to include individuals who began work before 2012.

Page 13-36

Research and Experimental (R&E) Credit.

Extension. The R&E credit is extended to amounts paid or accrued before January 1, 2012. Absent this change, the research credit expired in 2009.

Page 13-42

Employer Provided Child Care. The Act extends the credit for two years through 2012.

Page 13-44

Indian Employment Credit. The 2010 Tax Relief Act retroactively extends the Indian employment credit for two years to tax years beginning before Jan. 1, 2012.

Page 13-44

Non-business Energy Property Credit (Residential Energy Property Credit).

The 2010 Act extends the nonbusiness energy credit also known as the residential energy property credit for one year through 2011. For 2011, the credit is reduced to 10%. In addition, the Act reduces the maximum credit amount to a lifetime amount of $500 and must be reduced by previously allowed credits the taxpayer received. As revised, no more than $200 of the credit amount can be attributed to exterior window and skylights.

Page 13-47

Child and Dependent Care Credit. This credit was scheduled to revert back to its pre EGTRRA form, which generally would result in lower credit amounts. The Act continues the credit in its current form for 2011 and 2012.

Page 13-52

Education Credits. The Act extends the American Opportunity Credit in its present form for 2011 and 2012

Page 13-56

Adoption Credit. The 2010 Patient Protection and Affordable Health Care Act (PPACA) enacted on March 3, 2010 provided a one-year postponement of the EGTRRA sunset for the adoption credit modifications. In addition, it increased the maximum per-child credit to $13,170 for 2010 and made it a refundable credit for 2010. As adjusted for inflation, this credit will be $13,360 for 2011. The phase-out for 2011 starts at $185,210 and is fully eliminated when modified AGI reaches $225,210. However, the 2010 Act did not continue the PPACA changes, which will cause the credit to drop.

Page 13-60

Earned Income Credit (EIC). A number of provisions relating to the EIC were scheduled to expire after 2010. However, under the Act, these are continued for 2010, 2011 and 2012. These include (1) the definition of earned income; (2) the relationship test; (3) use of AGI instead of modified AGI; (4) the tie-breaking rule; (5) and (6) increases in the beginning and ending points of the credit phase-out for married taxpayers by $5,000. The 2010 Tax Relief Act also extends for two years, through 2012, the 45% rate for taxpayers with three or more qualifying children and the higher phase-out thresholds for married couples filing joint returns.

CHAPTER 14: PROPERTY TRANSACTIONS: BASIS DETERMINATION AND

RECOGNITION OF GAIN OR LOSS

Page 14-11

Broker Reporting of Basis. Currently, brokers must supply an information return, Form 1099 B, to the taxpayer and government, concerning sales of securities. The Form must show the name, address, and taxpayer identification number of the customer for whom the sale was made, the property sold, the Committee on Uniform Security Identification Procedures (CUSIP) number of the security sold (if known), the gross proceeds of the sale, the date on which the sale occurred (the trade or settlement date, whichever the broker uses on a consistent basis), and any other information required by the relevant return. Beginning in 2011, brokers also will be required to report the taxpayer’s adjusted basis in any “covered securities” sold and whether any gain or loss with respect to the security is short-term or long-term. Covered securities generally include stocks, bonds, commodity contracts, notes and certain other financial instruments that were acquired through the broker or that were transferred from an account in which the security was a covered security (but only if the broker received a statement with respect to the transfer). Brokers that transfer securities must supply the new broker with the basis information. The new rule was created because of the belief of many that there may be significant underreporting of capital gain income as a result of misreporting of basis. Requiring brokers to report basis to IRS and taxpayers may reduce capital gain underreporting.

Page 14-30

Planning with Installment Sales.

The changing tax law has put taxpayers in a precarious position particularly with installment sales. If a taxpayer sells property with a note that extends beyond 2012, the tax on any LTCGs that would be recognized in 2013 or later could increase dramatically. The tax on LTCGs could increase by 33% (i.e., from 15% to 20%). And, if the 3.8% Medicare tax on unearned income is not repealed, the effective tax rate increase would be almost 60% (i.e., from 15% to 23.8%).

CHAPTER 16: PROPERTY TRANSACTIONS: CAPITAL GAINS AND LOSSES

Page 16-14

Prior to the enactment of EGTRRA in 2001, the maximum rate of tax on an individual's long-term capital gain was generally 20%. This rate was schedule to return but was postponed by the Act. For 2010, 2011 and 2012, the tax rates remain at 15% (0% for taxpayers otherwise in the 15% or 10% brackets).

Special 18 Percent Capital Gains Tax Rate. The special capital gains tax rate of 18% for gains on the sales of capital assets held for more than five years was scheduled to return in 2011. However, the Act postpones the return to 2013.

Page 16-28

Qualified Small Business Stock Exclusion (§ 1202). This provision, sometimes referred to as the darling of Wall Street, allows investors in eligible businesses to exclude no less than a whopping amount of gain on the sale of eligible stock. Generally, if the stock is held for more than five years, the exclusion is 50 percent of the gain realized. However, recent changes enabled taxpayers to exclude even more. The American Recovery and Reinvestment Act of 2009 increased the exclusion to 75% of the gain for stock acquired after February 17, 2009 and before September 28, 2010, assuming the stock is held for more than five years. . The Small Business Jobs Act of 2010 increased the exclusion. Under the Jobs Act, taxpayers may exclude all of the gain—100 percent—on the disposition of qualified small business stock acquired during a brief window of opportunity: after September 27, 2010 and before January 1, 2011. At that point, the exclusion was scheduled to revert to 50% for stock acquired after December 31, 2010. However, the 2010 Act extends this provision for one year so that taxpayers may continue to exclude 100% of gain from the disposition of qualified small business stock acquired before Jan. 1, 2012! Note that such stock must be held for five years in order to obtain the special treatment.

Not all is roses for § 1202 stock. A portion of the gain is considered a tax preference item subject to the alternative minimum tax. The amount identified as a preference item currently is 7% of the excluded gain and was schedule to return to the pre-EGTRAA level of 42% in 2011. However, the Act extends the 7% rate through 2011 and 2012.

For an interesting case involving an employee who converted options in his target employer for options Intel and tried to qualify for the exclusion, see S. Natkunanathan 99 TCM 1071,

CHAPTER 18: EMPLOYEE COMPENSATION AND RETIREMENT PLANS

Page 18-28

Contributions from IRAs. The Act extends the tax-free treatment of qualified charitable distributions for two additional tax years—2010 and 2011. Thus, taxpayers age 70 1/2 or older may exclude from gross income up to $100,000 of their qualified charitable distributions for each tax year beginning in 2010 and 2011.

Page 18-31

Coverdell Educational Savings Accounts. The contribution limitation for CESAs was scheduled to revert to pre- EGTRRA law when the maximum contribution was $500. The Act extends the current rules allowing contributions of up to $2,000 for 2010 and 2011.

***************

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download