You have all probably heard that on December 17, 2010, President Obama signed the 2010 Tax Relief Act, which is actually called the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The main purpose of this act was, depending on your political views, to either extend the Bush era tax cuts which were set to expire January 1, 2011 or repeal the Bush era tax increases which were set to go in effect on January 1, 2011.
This 2010 Tax Relief Act is only temporary for two years, 2011 and 2012. Unless Congress acts again before January 1, 2013, the tax increases will come back automatically at that time. Although news reports stated that the new act would just continue the status quo from 2010, there were additional tax and other changes made. There were also a number of companion bills which affected federal taxes that had little, if any, media coverage, that were also shepherded through Congress at the end of the legislative term.
There was the Claims Resolution Act signed on December 8, 2010, the Medicare and Medicaid Extenders Act signed on December 15, 2010, the Regulated Investment Company Modernization Act of 2010 signed on December 22, 2010, the Airport and Airway Extension Act also signed on December 22, 2010, the Omnibus Trade Act of 2010 signed on December 29, 2010 and the James Zadroga 9/11 Health and Compensation Act signed into law on January 2, 2011.
The most obvious provisions that you will see in 2011 are the individual Federal income tax rates and tax brackets. The rates and brackets from 2010 to 2011 will stay the same, to be adjusted only by inflation. This means the individual Federal income tax rates will be staying at 10%, 15%, 25%, 28%, 33% and 35%.
Another Federal tax change that you will see if you work, is a 2% Social Security tax holiday for employees and self-employed individuals. For 2011 only, instead of paying the employee’s share of 6.2% Social Security tax on your wages or 12.4% on your self-employment earnings, you will only pay 4.2% on your wages or 10.4% on your self-employment earnings.
The individual retirement account (“IRA”) tax-free charitable contribution provision has been retroactively reinstated for 2010 and 2011. If you are age 70½ or older in 2010 or 2011, you may make a tax-free distribution of your IRA to a charity of up to $100,000 per year. If you wanted to make a tax-free charitable distribution in 2010 but did not, there is still a chance to do so. You may elect to treat any such IRA distributions you make in January 2011 as being made in 2010.
There were also numerous changes to tax credits, exemptions and deductions that now must be incorporated into the Federal tax forms and Internal Revenue Service (“IRS”) computer programs. The IRS has already announced that income tax refunds will be delayed because of the time needed to reprogram their computers to accommodate all the changes Congress made two weeks before the end of the year.
In addition to all these income tax changes, there are also Federal gift and estate tax changes. There has been an increase in the amount of property that you can pass tax free to your beneficiaries both during your lifetime and upon your death.
Prior to the 2010 Tax Relief Act, in 2011 and thereafter, you would have only been able to give up to $1 million to your beneficiaries tax free during your lifetime or upon your death. This meant that a married couple could only leave $2 million to their family that could escape this confiscatory tax that was as high as 55%.
Under the new act, retroactive to January 1, 2010 and through 2012, any lifetime or death transfer you make would only be subject to any gift or estate taxes when your total lifetime and death taxable transfers exceed $5 million. If your total taxable transfers do exceed $5 million, they are now only subject to a top rate of 35%.
The generation-skipping transfer tax has now become unified with the estate and gift tax. The exemption for the generation-skipping transfer tax is also $5 million with a top rate of 35%.
If you are married and have properly drafted trusts, you and your spouse can now transfer up to $10 million to your beneficiaries and still escape all Federal and Michigan gift, estate and inheritance taxes. It is estimated that the 2010 Tax Relief Act will eliminate estate taxes from all but 1% or 2% of estates. This is great news for almost everybody except that 1% or 2%.
Before December 17, 2010, there was no estate tax for anyone who died in 2010, even if you were a billionaire. Remember George Steinbrenner. This estate tax elimination in 2010 was repealed, sort of, with the 2010 Tax Relief Act. Under the new rules, if you died in 2010 and had a taxable estate greater than $5 million, it would be subject to estate taxes. However for 2010 deaths only, your survivors can make a special election to not be subject to the new Federal estate tax and be taxed under the old law of no estate tax.
If your survivors make this no-estate-tax election, they will get a carry-over of your basis in the property transferred upon your death. To determine your basis, they have to determine what you originally paid for the property and then reduce it by any depreciation or other adjustments you took. When the property is eventually sold, your beneficiaries will pay capital gains taxes on the difference between your basis and the sales price.
If your beneficiaries do not make this no-estate-tax election and you died in 2010, 2011 or 2012, your beneficiaries get a full step-up in basis for any property received from your estate equal to its fair market value on your date of death. What this means is that when your beneficiaries eventually sell your property, they only have to pay capital gains taxes on the increase in value since your date of death.
So I guess there were a few beneficial provisions of the 2010 Tax Relief Act despite the last minute rush by a lame-duck Congress. It does help even more if your estate is less than $5 million. You then can pass your entire estate to your beneficiaries estate tax-free, but only if you die in 2011 or 2012.
By: Matthew M. Wallace, CPA, JD
Published edited January 16, 2011 in The Times Herald newspaper, Port Huron, Michigan as: Taxpayers catch gift, inheritance break