New Tax Laws: Strategies to Consider before Year-End 2010December 2010
New tax legislation, named the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, was signed into law on December 17. It extends the Bush-era tax cuts for an additional two years for taxpayers of all income levels. The legislation also includes a temporary solution for the estate tax, a payroll tax cut for all workers, an extension of unemployment benefits, a two-year patch for the AMT, as well as several other provisions (see Tax Law Highlights below).
The Act eliminates the need for taxpayers to take measures they may have considered if the Bush-era tax cuts had not been extended—including taking capital gains this year, accelerating income into 2010 and postponing charitable contributions. However, there are still several strategies to consider implementing now, before the 2010 laws expire at year end.
STRATEGIES TO CONSIDER BEFORE YEAR END
1. Make Gifts to Grandchildren
The Generation Skipping Transfer (GST) tax is a separate Federal tax that is imposed on top of the Federal gift tax (for lifetime gifts) and the Federal estate tax (for assets passed at death). The suspension of the GST tax in 2010 made gifting to grandchildren (or other remote descendents) incredibly tax-effective. The GST tax will go up from 0% in 2010 to 35% in 2011 and 2012.
It was uncertain under the prior law whether gifts made to a minor grandchild via a trust or an UTMA would be protected from any future GST tax. By reinstating the GST tax, the Act makes it clear that gifts to trusts and UTMA accounts can be sheltered from future GST tax.
2. Postpone Large Gifts to 2011
Taxpayers planning to make taxable gifts over $1 million (or in excess of their remaining gift tax exclusion amount) might consider delaying those gifts until 2011 so that they can take advantage of the larger $5 million gift tax exclusion available next year. This year’s lower $1 million gift tax exclusion is still in place through December 31, 2010, and gifts made above this amount in 2010 are subject to the 35% gift tax.
3. Convert to a Roth IRA
IRA holders who are considering converting to a ROTH IRA should do so before December 31, 2010 to take advantage of a special tax break. Assets that are converted in 2010 are allowed to be spread over two years, thereby also distributing the tax liability over the two year timeframe. IRA assets converted to a ROTH on or after January 1, 2011 will be subject to the entire tax bill in the year the conversion is made.
4. Donate IRA Assets to Charity
The Act extends a provision that permits direct distributions to charitable organizations from an IRA of up to $100,000 per taxpayer, per tax year for 2010 and 2011. IRA holders who have reached age 70 ½ may consider making a distribution up to the $100,000 allowable limit from their IRA directly to a charity. The Act also allows IRA assets to be transferred to a charity in January of 2011 and still be treated as a 2010 distribution.
5. Disclaim an Inheritance
Given the suspension of the GST tax for 2010, another strategy to consider before year end may be to disclaim an inheritance. This means if individuals inherit wealth this year from their parents’ estate or from another source, they may make a disclaimer and pass this inheritance directly through to their own children, free of both Federal estate and GST taxes. It is important to note that for this strategy to be effective, the recipient of the inheritance must not have already accepted the property. The disclaimer must be made within nine months of the decedent’s date of death and must comply with certain other statutory requirements.
TAX LAW HIGHLIGHTS
- Federal Income and Capital Gains Tax Rates: Cuts Extended
The 2010 federal income, capital gains and dividend tax rates have been extended for two more years, to 2012.
- Alternative Minimum Tax: A Two Year Patch
The Act provides an AMT "patch" intended to protect middle-income taxpayers from being subject to the AMT. The law increases the exemption amounts for 2010 to $47,450 for individuals and $72,450 for married couples filing jointly. For 2011, exemptions increase even more, to $48,450 for individuals and $74,450 for married couples filing jointly. These increased exemptions ensure that approximately 20 million additional Americans will not have to pay AMT this year or next.
- Employee-Paid Social Security Payroll Taxes: A One-Year Reduction
The law reduces employee-paid social security taxes by 2% for 2011 for all filers, regardless of income. This means employees will pay just 4.2% on earned wages next year, vs. the current 6.2%. The self-employed will pay 10.4% Social Security self-employment taxes, down from 12.4% in 2010. These reductions are for 2011 only and apply only to the first $106,800 in income.
- Itemized Deduction Limitation Repeal: Extended to 2012
The limitation reducing the total amount of a higher-income individual’s otherwise allowable deductions was repealed for 2010, but was scheduled to return in full after 2010. The Act extends the repeal of this limitation and allows full deductibility for charitable contributions and other deductible items, regardless of income level.
- Personal Exemption Phaseout: Extended to 2012
The 2010 Tax Relief Act extends the repeal of the personal exemption phaseout for two more years, through December 31, 2012. Without the two year extension, the phaseout would have reduced the value of exemptions allowable for high-income taxpayers.
- Marriage Penalty Relief: Extended to 2012
The Act extends marriage penalty relief for two years through 2012. This relief was intended to mitigate the so-called “marriage penalty” by increasing the standard deduction for a married couple filing a joint return to twice the amount for a single individual. In addition, the size of the 15% income tax rate bracket was temporarily expanded for married couples filing a joint return to twice that of single filers.
- Federal Estate Tax: Reinstated at 35%
The new law revives the Federal estate tax at a maximum rate of 35% with an exclusion amount of $5 million and a stepped-up cost basis.
Estate tax option for 2010
The Act gives estates of decedents dying in 2010 the option to elect to apply either (1) the new estate tax based on the 35% top rate and the $5 million exemption, along with the stepped-up cost basis rule or (2) no estate tax, along with the modified carryover cost basis rule from 2010. Executors will have nine months after December 17th to make this decision.
- Gift Tax: An Increased Exclusion amount
Gifts made in 2010 have been subject to a 35% gift tax for any gift above a $1 million exclusion. The new law retains the 35% rate, but increases the maximum applicable exclusion amount to $5 million for gifts made in 2011 and 2012.
- Generation Skipping Transfer Tax: Reinstated at 35%
For gifts made to grandchildren or other more distant generations in 2011 and 2012, the GST tax rate will be reinstated from 0% to a 35% rate, with a $5 million exclusion.
- Exemptions for Married Couples: Unused Portions Are Portable
The Act provides for "portability" between spouses of the maximum exclusion. This allows a surviving spouse to take advantage of any unused portion of their deceased spouse’s $5 million exclusion. The surviving spouse must make this election on a filed estate tax return. This communication is intended to provide general information.
The information and opinions stated are as of December 21, 2010, unless otherwise indicated, and do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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