Client Bulletin 8-16-10:Tax Law Changes in 2010–And Beyond

With the looming expiration of many of the income tax benefits passed over the last decade, federal income tax rates in 2010 may be at their lowest levels for some time to come. The following discussion summarizes some of the more better known expiring tax benefits and suggests some ways to help you plan to minimize your tax expense in light of pending increases in federal income tax rates.

Starting in 2011

Over the past several years a variety of income tax reductions were enacted by Congress (absent congressional action in the next several months) the following federal tax laws will no longer apply after 2010:

Higher Tax Rates: Beginning in 2011, tax rates in effect prior to 2001 spring back into effect. The top income tax rate returns to 39.6%, and the special low 10% bracket is eliminated. Whether this will actually happen will be at the heart of a spirited battle in Congress.

Estate Tax Revived: For individuals dying after 2010, the federal estate tax returns with a $1 million exemption and a 50% maximum rate. Congress is likely to take some action on these rules during 2010.

Increase in Capital Gains and Dividend Tax Rates: The tax rate reductions for long-term capital gains and dividends is scheduled to expire after 2010.

• In 2011, the maximum long-term capital gains tax rate goes back up to 20% from 15%. A lower 10% tax rate is used by individuals to the extent that they are in the 15% tax bracket. Their long-term capital gains had been tax free since 2008.

• In 2011, dividend income (other than capital gain distributions from mutual funds) is taxed as ordinary income at your highest marginal tax rate.

Child Tax Credit: The credit of $1,000 per eligible child reverts to $500 after 2010. Additionally, none of the child tax credit will be refundable to taxpayers unless their earned income is more than $12,550.

Payroll Tax Credit: Starting in 2011, the partial credit for payroll taxes paid is no longer available.

Decreased Section 179 Expense Deduction: Taxpayers who purchase qualifying business property may elect to deduct the cost of the property (new or used) in the year that it is placed in service. This is referred to as a Section 179 deduction. In 2009 and 2010, the maximum amount of property that may be taken as a Section 179 deduction is $125,000, as indexed for inflation. In 2011 and future years, the maximum deduction drops to $25,000.

College Savings Plans: Beginning in 2011, 529 plans can no longer be tapped tax free to pay for a computer or Internet access.

Tax Credit for College Tuition: The Hope credit is again limited to the first two years of college and is capped at $1,800. None of the credit is refundable if it is more than your regular income tax liability.

Earned Income Tax Credit: Temporary increases in the earned income tax credit for filers with three or more children and the higher income levels for the phase-out of the credit are repealed.

Mortgage Insurance Premiums: The special itemized deduction for mortgage insurance premiums paid on mortgages taken out after 2006 expires on Dec. 31, 2010

There are several other tax law changes slated for expiration. A full list can be found at the end of this discussion.

What You Can Do.

In the face of rising tax rates, the general rule is to accelerate income and defer deductions. Whether you can control the timing of either and whether the general rule will in fact be helpful to you will depend on many factors. We would be very happy to discuss any of these issues with you before the end of the year and before undertaking any income tax planning steps. In the mean time, here are a few general ideas to consider that may be helpful depending on your circumstances.

The federal capital gains rate is scheduled to increase by about 33% in 2011. If you are planning to sell appreciated securities with unrealized appreciation within the next year or two, consider selling those securities in 2010, when the gain will be taxed at the lower rates. Similarly, you may wish to defer selling securities at a loss until next year, when those losses can offset 2011 capital gains taxed at the higher rate (or incur 2010 losses that could be carried forward to 2011).

You should also consider accelerating receipt of any ordinary income from 2011 to 2010 to the extent possible. For example, if you have nonqualified stock options that are vested and “in the money,” you may wish to exercise some of them in 2010.

If you can “time” deductions such as charitable contributions or state taxes, consider deferring the deductions. However, for married couples earning more than about $167,000 in 2011, an increased portion of your itemized deductions is slated to be disallowed next year and therefore the benefit of timing deductions could be reduced. Finally, you may wish to establish “529 plans” for your children or grandchildren’s education if you have not done so already (or add to existing plans). Assets in a 529 plan are not subject to income tax and remain income-tax free as long the funds are eventually used for qualified education expenses such as tuition, room, board, and books. Thus, 529 plans are tax-efficient options for gifting.

Provisions Expiring in 2010 Provision (Code section)

1. Sixty-five percent subsidy for payment of COBRA health care coverage continuation premiums ( Code Sec. 6432 and sec. 3001 of Pub. L. No. 111-5)

2. Airport and Airway Trust Fund excise taxes:

a. All but 4.3 cents-per-gallon of taxes on noncommercial aviation kerosene and noncommercial aviation gasoline ( Code Sec. 4081(d)(2)(B) ) 16

b. Domestic and international air passenger ticket taxes ( Code Sec. 4261(j)(1)(A)(ii) )

c. Air cargo tax ( Code Sec. 4271(d)(1)(A)(ii) )

3. First-time homebuyer credit ( Code Sec. 36(h) ) 17

4. Increase of the size of 15 percent rate bracket for married filers to double that of unmarried filers ( Code Sec. 1(f)(8) and sec. 901 of Pub. L. No. 107-16) 18

5. Reduced capital gain rates for individuals ( Code Sec. 1(h)(1)(B) , Code Sec. 1(h)(1)(C) , Code Sec. 55(b)(3)(B) , Code Sec. 55(b)(3)(C) , Code Sec. 57(a)(7) , Code Sec. 1445(e)(1) , Code Sec. 7518(g)(6)(A) and sec. 102 of Pub. L. No. 109-222) 19

6. Dividends of individuals taxed at capital gain rates ( Code Sec. 1(h)(11) , Code Sec. 163(d)(4)(B) , Code Sec. 854(a) , Code Sec. 854(b) and Code Sec. 857(c) and sec. 102 of Pub. L. No. 109-222)

7. Ten percent individual income tax rate ( Code Sec. 1(i) and sec. 901 of Pub. L. No. 107-16)

8. Reduction in other individual income tax rates – size of 15 percent rate bracket modified to reflect 10 percent rate, and 28 percent, 31 percent, 36 percent and 39.6 percent rates are reduced to 25 percent, 28 percent, 33 percent and 35 percent, respectively ( Code Sec. 1(i)(2) and sec. 901 of Pub. L. No. 107-16)

9. Dependent care credit – increase of dollar limit on creditable expenses from $2,400 to $3,000 ($4,800 to $6,000 for two or more children), increase of applicable credit percentage from 30 to 35 percent, increase of beginning point of phase-out range from $10,000 to $15,000 ( Code Sec. 21(a)(2) and Code Sec. 21(c) and sec. 901 of Pub. L. No. 107-16)

10. Adoption credit and adoption assistance exclusion – increase to $10,000 for maximum credit and maximum exclusion, special needs adoptions deemed to have $10,000 eligible expenses for purposes of credit and exclusion, increase the beginning and ending points of phase-out range for credit and exclusion, the credit is allowed against AMT ( Code Sec. 23 and Code Sec. 137 and sec. 901 of Pub. L. No. 107-16)

11. Child credit – increase from $500 to $1,000, expand eligibility for refundable portion of the credit, AMT relief, provide that child credit not treated as income or resources for purposes of benefit or assistance programs financed in whole or in part with Federal funds ( Code Sec. 24(a) and Code Sec. (b)(3) and Code Sec. 203 and sec. 901 of Pub. L. No. 107-16)

12. Refundable child credit floor amount ( Code Sec. 24(d) )

13. American Opportunity Tax credit ( Code Sec. 25A(i) )

14. Credit for certain nonbusiness energy property ( Code Sec. 25C(g) )

15. Alternative motor vehicle credit for advanced lean burn technology motor vehicles and qualified hybrid motor vehicles that are passenger automobiles or light trucks ( Code Sec. 30B(k)(2) )

16. Alternative motor vehicle credit for qualified alternative fuel vehicles ( Code Sec. 30B(k)(4) )

17. Alternative fuel vehicle refueling property – increase in credit rate and credit cap ( Code Sec. 30C(e)(6) )

18. Alternative fuel vehicle refueling property (non-hydrogen refueling property) ( Code Sec. 30C(g)(2) ) 21

19. Earned income tax credit (“EITC”) – increase in the beginning point of the phase-out range for joint returns, modification of EITC treatment of amounts not includible in income, repeal of reduction of EITC for AMT liability, expansion of math error authority ( Code Sec. 32(b)(2) , Code Sec. 32(c)(2)(A)(i) , Code Sec. 32(h) , and Code Sec. 6213(g)(2) and sec. 901 of Pub. L. No. 107-16)

20. Earned income tax credit:

a. Credit percentage of 45 percent for three or more qualifying children ( Code Sec. 32(b)(3)(A) )

b. Phaseout threshold for marriage penalty relief ( Code Sec. 32(b)(3)(B) )

21. Enhanced credit for health insurance costs of eligible individuals ( Code Sec. 35(a) )

22. Making work pay credit ( Code Sec. 36A )

23. Incentives for alcohol fuels

a. Alcohol fuels income tax credit (alcohol fuel, alcohol used to produce a qualified mixture, and small ethanol producers) ( Code Sec. 40(e)(1)(A) , Code Sec. 40(h)(1) , and Code Sec. 40(h)(2) )

b. Alcohol fuel mixture excise tax credit and outlay payments ( Code Sec. 6426(b)(6) and Code Sec. 6427(e)(6)(A) )

24. Credit for employer-provided child care ( Code Sec. 45F and sec. 901 of Pub. L. No. 107-16)

25. Credit for energy efficient appliances ( Code Sec. sec . Code Sec. 45M(b) )

26. Election of investment credit in lieu of production tax credit ( Code Sec. sec . Code Sec. 48(a)(5) )

27. Grants for specified energy property in lieu of tax credits ( Code Sec. 48(d) and sec. 1603 of Pub. L. No. 111-5)

28. Work opportunity tax credit targeted group status for unemployed veterans and disconnected youth ( Code Sec. 51(d)(14) )

29. Qualified zone academy bonds — allocation of bond authority( Code Sec. 54E(c)(1) )

30. Qualified school construction bonds — allocation of bond authority ( Code Sec. 54F(c)(3) )

31. Authority to issue Build America Bonds ( Code Sec. 54AA(d)(1)(B) and Code Sec. 6431(a) )

32. Modification of AMT limitations on tax-exempt bonds ( Code Sec. 57(a)(5)(C)(vi) and Code Sec. 56(g)(4)(B)(iv) )

33. Increase of the standard deduction for married filers to double that of unmarried filers ( Code Sec. 63(c)(2)(A) and sec. 901 of Pub. L. No. 107-16)

34. Repeal of overall limitation on itemized deductions (the “Pease limitation”) 23 ( Code Sec. 68(g) and sec. 901 of Pub. L. No. 107-16)

35. Deferral and ratable inclusion of income from business debt discharged by reacquisition ( Code Sec. 108(i) )

36. Elimination of tax on awards under the National Health Service Corps Scholarship Program and the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance Program ( Code Sec. 117(c)(2) and sec. 901 of Pub. L. No. 107-16)

37. Employer-provided educational assistance – expansion to graduate education and making the exclusion permanent ( Code Sec. 127(c)(1) and sec. 901 of Pub. L. No. 107-16)

38. Parity for exclusion from income for employer-provided mass transit and parking benefits ( Code Sec. 132(f) )

39. Exclusion from income for benefits provided to volunteer firefighters and emergency medical responders ( Code Sec. 139B )

40. Tax-exempt bonds for educational facilities – increase in amount of bonds qualifying for small-issuer arbitrage rebate exception, expansion of tax-exempt bond treatment to public school facilities ( Code Sec. 142(a)(13) and Code Sec. 142(k) , Code Sec. 148(f)(4)(D)(vii) and sec. 901 of Pub. L. No. 107-16)

41. Qualified mortgage bonds for refinancing of subprime loans ( Code Sec. 143(k)(12) )

42. Expansion of availability of industrial development bonds to facilities manufacturing intangible property ( Code Sec. 144(a)(12)(C) )

43. Volume cap increase and set-aside for private activity bonds for housing ( Code Sec. 146(d)(5) and Code Sec. 146(f)(6) )

44. Bonds guaranteed by Federal Home Loan banks eligible for treatment as tax-exempt bonds ( Code Sec. 149(b)(3)(A)(iv) )

45. Repeal of the personal exemptions phase-outs (“PEP”) for high income taxpayers 25 ( Code Sec. 151(d)(3)(F) and sec. 901 of Pub. L. No. 107-16)

46. Premiums for mortgage insurance deductible as interest that is qualified residence interest ( Code Sec. 163(h)(3) )

47. Five-year amortization of music and music copyrights ( Code Sec. 167(g)(8) )

48. Natural gas distribution lines treated as 15-year property ( Code Sec. 168(e)(3)(E)(viii) )

49. Increase in dollar limitations for expensing to $125,000/500,000 (indexed) ( Code Sec. 179(b)(1) and Code Sec. 179(2) , Code Sec. 179(c)(2) , and Code Sec. 179(d)(1)(A)(ii) ) 26

50. Student loan interest deduction – increase and indexation for inflation of the phase-out ranges, repeal of the limit on the number of months that interest payments are deductible, repeal of the rule that voluntary payments of interest are not deductible ( Code Sec. 221 and sec. 901 of Pub. L. No. 107-16)

51. Modification of small issuer exception to tax-exempt interest allocation rules for financial institutions ( Code Sec. 265(b)(3)(G) )

52. De minimis safe harbor exception for tax-exempt interest expense of financial institutions ( Code Sec. 265(b)(7) and Code Sec. 291(e)(1)(B)(iv) )

53. Repeal of collapsible corporation rules ( Code Sec. 341 and sec. 102 of Pub. L. No. 109-222)

54. Computer technology and equipment allowed as a qualified higher education expense for section 529 accounts ( Code Sec. 529(e)(3)(A)(iii) )

55. Education IRAs (Coverdell education savings accounts) – increase of maximum annual contribution from $500 to $2,000, expansion of definition of qualified education expenses, increase in the size of the phase-out range for married filers to double that of unmarried filers, provision of special needs beneficiary rules, contributions by corporations and other entities, and contributions until April 15th, permitted ( Code Sec. 530(b)(1) , Code Sec. 530(b)(2) , Code Sec. 530(b)(4) , Code Sec. 530(c)(1) , Code Sec. 530(d)(2) and sec. 901 of Pub. L. No. 107-16)

56. Modified tax treatment of electing Alaska Native Settlement Trusts and their beneficiaries ( Code Sec. 646 and sec. 901 of Pub. L. No. 107-16)

57. Modified carryover basis rules for property acquired from a decedent who dies during 2010 27 ( Code Sec. 1022 , Code Sec. 1040 , Code Sec. 6018 , and Code Sec. 6716 and sec. 901 of Pub. L. No. 107-16)

58. Special rules for qualified small business stock ( Code Sec. 1202(a)(3) )

59. Reduction in S corporation recognition period for built-in gains tax ( Code Sec. 1374(d)(7) )

60. Authority to issue recovery zone economic development bonds and facility bonds ( Code Sec. 1400U-2(b) and Code Sec. 1400U-3(b) )

61. Estate tax deduction for State death taxes paid 28 ( Code Sec. 2011 , Code Sec. 2053 , Code Sec. 2058 , Code Sec. 2102 , Code Sec. 2106 , and Code Sec. 2604 and sec. 901 of Pub. L. No. 107-16)

62. Expansion and clarification of estate tax conservation easement rules ( Code Sec. 2031(c)(2) and Code Sec. 2031(c)(8)(A)(i) and sec. 901 of Pub. L. No. 107-16)

63. Temporary repeal of the estate and generation-skipping transfer taxes ( Code Sec. 2210 and Code Sec. 2664 and sec. 901 of Pub. L. No. 107-16) 29

64. Reduction in the maximum gift tax rate to 35 percent 30 ( Code Sec. 2502 and sec. 901 of Pub. L. No. 107-16)

65. Treatment of certain transfers in trust as taxable gifts under section 2503 ( Code Sec. 2511(c) and sec. 901 of Pub. L. No. 107-16)

66. Repeal of the qualified family-owned business deduction ( Code Sec. 2057 and sec. 901 of Pub. L. No. 107-16)

67. Modifications to generation-skipping transfer tax rules regarding deemed allocations of exemption to certain transfers in trust, severing of trusts, valuation, and relief for late elections ( Code Sec. 2632(c) and Code Sec. 2642(a)(3) , Code Sec. 2642(b)(1) and Code Sec. 2642(b)(2)(A) and sec. 901 of Pub. L. No. 107-16)

68. Modifications to estate tax installment payment rules ( Code Sec. 6166(b)(1)(B)(ii) , Code Sec. 6166(b)(1)(C)(ii) , Code Sec. 6166(b)(8)(B) , Code Sec. 6166(b)(9)(B)(iii)(I) and Code Sec. 6166(b)(10) and sec. 901 of Pub. L. No. 107-16)

69. Expand from 90 days to 120 days the postponement of certain tax related deadlines in the case of Presidentially-declared disasters ( Code Sec. 7508A(a) and sec. 901 of Pub. L. No. 107-16)