recent changes in affecting individuals, part 1 businesses

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Recent Changes in Federal Tax Laws Affecting Individuals, Businesses, and Estates1

Part 1 Introduction and References

Introduction Major changes have been made in Federal tax law over the past year affecting all U.S. taxpayers. The most significant of these were sweeping revisions, primarily extensions of past provisions, of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 TRA), signed into law by the President on December 17, 2010. Other legislative actions during 2010, also included important tax provisions, including the Small Business Jobs Act of 2010 (2010 SBJA), which was signed September 27, 2010. The 2010 TRA was particularly important, however, because of the pending expiration of many provisions of the 2001, 2003, and 2009 tax bills at the end of 2010.2 The expiration of this legislation, which had reduced taxes for most individuals, businesses, and estates, would have generally resulted in federal tax increases in 2011. The 2010 TRA extends many, but not all, of the tax reductions in these three pieces of tax legislation. A few provisions are retroactive to 2010. Others are effective in 2011. Most expire at the end of 2012. Some new tax features are introduced, as well. The purpose here is to outline those various extensions and changes expected to be of general interest to individual taxpayers, small businesses, and estate administrators. Some background is included on previous tax treatment in each area to put the changes in perspective. The publication is organized in four parts:

Part 1. Introduction and References Part 2. Changes Affecting Individuals Part 3. Changes Affecting Businesses Part 4. Changes Affecting Estates

The IRS is still issuing regulations covering the provisions of the new law. Future rulings will also change the interpretations of these laws. So this publication is no substitute for professional advice from tax professionals familiar with the latest rulings and their application to individual business decisions. A few of the more important provisions of the 2010 TRA include:

1. The social security tax paid by employees and self-‐employed is reduced by 2% in 2011. 2. The 2010 individual income tax rates and capital gains and dividend rates are extended for 2011

and 2012.

1 Prepared by A. Gene Nelson, Professor, Department of Agricultural Economics, [email protected], April 2011. Appreciation is expressed to the reviewers of this report: Ashley Lovell, Professor of Agricultural Economics, Tarleton State University; Wayne Hayenga, Professor and Extension Economist-‐Emeritus; Jose G. Peña, Professor and Extension Economist; and Mark Waller, Professor and Associate Head for Extension Economics. Hayenga, Any errors or omissions are the author’s responsibility. 2 These bills were the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003, and the American Recovery and Reinvestment Act (ARRA) of 2009.

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3. The impact of the Alternative Minimum Tax (AMT) is temporarily decreased for 2010 and 2011 by raising the AMT exemptions.

4. Business investment incentives are continued with bonus depreciation and expensing options. The 50% bonus depreciation was increased to 100% for qualifying property purchases September 9, 2010, through December 31, 2011. The 50% bonus depreciation will be available for 2012 purchases. The $500,000 Section 179 expensing deduction is extended through 2011, and then decreases to $125,000 in 2012 and $25,000 thereafter.

5. The federal estate tax exemption was set at $5 million at a rate of 35% for taxpayers dying after December 31, 2009, and estate assets will receive a stepped-‐up basis. However, estates resulting from 2010 deaths may elect to use the old 2010 law with no estate tax and be subject to the modified carryover basis instead.

For most taxpayers, the new law means that the income tax situation for 2010, 2011 and 2012 will be very similar to 2009. This is because the 2010 Tax Reform Act extended most of the tax provisions that expired at the end of 2009 and 2010.3 The other important point is that most of the provisions are temporary extensions for two years, through 2012. Unless Congress acts before then, taxpayers in 2012 will again be facing the prospects for tax law to revert to earlier provisions with higher tax rates in 2013 – similar to the situation they faced in 2010.

3 The 2010 TRA also included some important non-‐tax provisions. Unemployment benefits were extended at their current level for 13 months. The ethanol tax credit and the import tariff on imported ethanol were extended through 2011, and the production tax credit for biodiesel and diesel from biomass were extended through 2011.

Remember... Interpretations and regulations are subject to change. For the most recent rules, contact the IRS or a tax professional.

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References Harris, Philip E., and Linda E. Curry, “2010 National Income Tax WorkbookTM Update,” Land Grant University Tax Education Foundation, Inc., January 31, 2011. Hoff, Gary J., and Ruby Ward on Agriculture Tax Issues, “Ag and the Tax Relief Act of 2010 – Key Changes for Farmers and Ranchers,” Webinar Recording, February 7, 2011. http://www.farmmanagement.org/aginuncertaintimesenglish/?p=2130 Internal Revenue Service, Farmer’s Tax Guide, Publication 225, October 28, 2010. http://www.irs.gov/pub/irs-‐pdf/p225.pdf National Farm Income Tax Extension Committee, “Rural Tax Education,” Website hosted Utah State University Cooperative Extension. http://www.ruraltax.org/ Patrick, George F. “Depreciation and Expensing Options,” Rural Tax Education, RTE/2011-‐24, Jan. 2011. https://ruraltax.org/files/uploads/Depreciation%20and%20Expensing%20Options%20for%20Farmers%20(RTE%202011-‐24).pdf Schimpler, Carolyn, “What’s New Supplement,” University of Illinois Tax School, January 20, 2011. http://www.taxschool.illinois.edu/PDF/2011Whatsnew.pdf Senate Finance Committee, “Summary of the Reid Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010,” December 9, 2010. http://finance.senate.gov/legislation/details/?id=10874ed6-‐5056-‐a032-‐52cd-‐99708697eff0 Tax Education programs: The Land Grant University Tax Education Foundation, Inc.: http://www.taxworkbook.com/ University of Illinois Tax School: http://www.taxschool.illinois.edu/index.html For information about the Tax Practitioner Workshops offered annually across Texas, go to: http://www.taxworkshop.com/index.php

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Recent Changes in Federal Tax Laws Affecting Individuals, Businesses, and Estates

Part 2 Changes Affecting Individuals

Changes Affecting Individuals Many of the provisions of federal tax laws enacted in the early 2000s were set to expire in 2011. As a result, tax rates would have reverted to pre-‐2001 levels, and several tax deductions and credits were to be discontinued. As a result, most taxpayers were anticipating tax increases for 2011 and later years. The general effect of the 2010 TRA is to continue the provisions of the earlier tax laws, some through 2011 and others through 2012. One change, in particular, resulting from the 2010 TRA affecting all taxpayers is the extension of 2010 federal income tax rates that would have otherwise reverted to pre-‐2001 levels. Individual Income Tax Rates. The federal income-‐tax rates were scheduled to increase in 2011 and after, compared to the 2010 rates. Effective January 1, 2011, the individual income tax rates would have reverted to the higher levels in effect before the passage of EGTRRA in 2001. The 2010 TRA extends the 2010 ordinary income tax rates for two years, through December 31, 2012. Table 1 compares the tax rates that would have been in effect in 2011-‐2012 to those in effect with the 2010 TRA. Table 1. Individual Tax Rates for Married Taxpayers, Filing Jointly 2010 Taxable Income

Brackets* 2010 Tax Rates Scheduled Tax Rates for

2011-‐2012 Before 2010 TRA Tax Rates for 2011-‐2012

After 2010 TRA $0 to 16,750 10% 15% 10%

$16,750 to 68,000 15% 15% 15% $68,000 to 137,300 25% 28% 25% $137,300 to 209,250 28% 31% 28% $209,250 to 373,650 33% 36% 33%

Over $373,650 35% 39.6% 35% *These taxable income brackets for married taxpayers filing jointly are used as a point of reference. The brackets will be adjusted for inflation in 2011 and 2012. What does this mean for taxpayers? What will be the difference in taxes paid compared to what they would have paid without the passage of the 2010 Tax Relief Act? The tax calculations in Table 2 are based on a married couple filing jointly with two dependents.4 Although the differences in the dollar amounts of taxes due are greater for the higher income levels, the percentage reductions are highest at the lower income levels.

4 Calculated using the Tax Foundation’s federal income calculator at http://www.mytaxburden.org/.

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Table 2. Differences in Income Taxes Due for a Married Couple Filing Jointly* Adjusted

Gross Income 2011 Taxes Before TRA

2011 Taxes After TRA

Difference in Taxes Due

Percent Reduction

$30,000 $833 $360 $473 57% $50,000 $3,833 $2,690 $1,143 30% $80,000 $8,333 $7,190 $1,143 14% $120,000 $19,260 $15,650 $3,610 19% $170,000 $33,446 $28,278 $5,168 15%

*Income taxes due before credits Capital Gains and Qualified Dividends. Net capital gain income is net long-‐term gains (assets held longer than one year) minus net short-‐term losses.5 The tax rates on net capital gains have been 0% for individual taxpayers below the25% income bracket and 15% for individuals in the 25% bracket and above. In 2011, however, these rates would have reverted to 10% and 20% of the net capital gain. With the 2010 TRA, these rates of 0% and 15% are temporarily extended through 2012. Whether the tax rates on capital gains revert to higher levels in 2013 will depend on what Congress does or does not do adding uncertainty to decisions about when to sell appreciated assets. Qualified dividends (those received from domestic corporations and certain foreign corporations) will continue to be taxed at 0% and 15% rates, the same as net capital gains in 2011 and 2012. Without the enactment of the 2010 TRA, these dividends would have been subject to ordinary income rates. Marriage Penalty Relief. The provision to reduce the tax penalty for married taxpayers compared to single taxpayers was due to expire at the end of 2010. These provisions included adjusting the lower income tax brackets and the standard deduction. Under the 2010 TRA, the marriage penalty relief is extended through 2012. Social Security Taxes. For 2011 only, the 2010 TRA reduces the Social Security (FICA-‐OASDI) tax rate paid by employees on wages earned up to $106,800 by 2% from 6.2% to 4.2%. This benefit, amounting to as much as $2,136 per worker, showed up as reduced withholding rates in January 2011 paychecks (Table 3). The employers’ contributions to Social Security taxes are not affected. For self-‐employed individuals, the Social Security tax rate is reduced from 12.4% to 10.4% for the 2011 tax year. Table 3. Social Security Tax Rate Reduction per Employee, 2011

Total Wage or Salary Reduction in Tax Due $30,000 $600 $50,000 $1,000 $70,000 $1,400 $106,800 $2,136 $120,000 $2,136

5 For more information on how to calculate net capital gain, see IRS Publication 550, Investment Income and Expenses (Including Capital Gains and Losses), for use in preparing 2010 Returns.

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Alternative Minimum Tax (AMT). The AMT was created to ensure that high-‐income individuals pay at least a minimum amount of income tax. Taxpayers calculate their tax liability using both the regular 1040 income tax form and the AMT worksheet, and then pay the higher of the two amounts. To calculate the AMT, the taxpayer starts with the regular taxable income and then adds the applicable adjustments and preference items.6 A special AMT exemption is subtracted from this recalculated income, and the difference is subject to tax rates of 26 percent for incomes below $175,000, and 28 percent for incomes above. The problem is that this AMT exemption is not indexed for inflation. As a result, more taxpayers, particularly those with certain significant deductions and credits are paying the higher AMT. This provision of the 2010 TRA to increase the AMT exemptions is retroactive to 2010 and extends through 2011. The increased exemption amounts for 2010 and 2011 are compared to the 2009 levels in Table 4. Table 4. Alternative Minimum Tax (AMT) Exemptions

2009 2010 2011 Married joint filers and surviving spouses $70,950 $72,450 $74,450

Unmarried individuals $46,700 $47,450 $48,450 Married individuals who file separate $35,475 $36,225 $37,225

Personal Exemptions and Itemized Deductions. Personal exemptions allow a deduction from taxable income for each taxpayer and dependent.7 Prior to 2010, however, the total exemption that could be claimed was reduced or phased out for taxpayers with adjusted gross income (AGI) above certain levels. This reduction was eliminated in 2010, but the phase out was scheduled to come back in 2011. Now the 2010 TRA continues this elimination of the personal exemption phase out for 2011 and 2012. This means that all taxpayers will get the full benefit of their personal exemptions regardless of their income levels. Also prior to 2010, taxpayers, who itemized deductions when the total deductions are more than the standard deduction amount, were subject to a limitation or reduction of their allowable itemized deductions for the year if their AGI exceeded certain amounts. Again, this reduction was eliminated in 2010, but was scheduled to come back in 2011 until the new tax law extended the elimination through 2011 and 2012. 6 The calculation of income for the AMT disallows many of the deductions and tax preferences allowed by the regular income tax, including personal exemptions, standard deduction, state and local tax deductions, interest on second mortgages, net operating losses, certain medical expenses, accelerated depreciation, various tax credits, and other items. See http://www.irs.ustreas.gov/pub/irs-‐pdf/i6251.pdf. 7 For 2010, the amount for each personal exemption is $3,650; for 2011, the personal exemption increases to $3,700.

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Itemized Deduction for Sales Tax. The tax laws allowing an itemized deduction to be claimed for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes has been an important advantage for Texas taxpayers who itemize rather than take the Standard Deduction. The temporary provision for the sales tax deduction election expired after 2009, but the 2010 TRA retroactively extends this option for two years, 2010 and 2011. Deductions for Non-‐Itemizers. Some benefits for individual taxpayers who do not itemize were allowed to expire. For example, in 2008 and 2009, taxpayers who did not itemize could write off up to $500 or $1,000 of state and local real property taxes by claiming an increased standard deduction. This benefit was not restored by the 2010 TRA. Another provision not extended for non-‐itemizers is the 2009 deduction for state sales tax or other fees paid on the purchase of new cars that was enacted by the American Recovery and Reinvestment Act of 2009. IRA Distributions for Charitable Purposes. Under prior law, taxpayers, who are age 70½ or over, could exclude from gross income IRA distributions, which would otherwise be taxable, when made to qualified charities. The exclusion could not exceed $100,000 per taxable year and was available through 2009. The 2010 TRA extends the exclusion for 2010 and 2011. Provisions for Families and Children. Several provisions of the 2010 Tax Relief Act are important for families.

• Child Tax Credit. Taxpayers with income below certain threshold amounts may claim the Child Tax Credit to reduce regular income tax and AMT for each qualifying child under the age of 17. For 2010, the maximum amount of the child tax credit was $1,000 per child and was scheduled to revert to $500 in 2011. Taxpayers are eligible for an additional refundable Child Tax Credit equal to 15% of earned income in excess of a threshold amount. This threshold was reduced from $10,000 to $3,000 for both 2009 and 2010 by the American Recovery and Reinvestment Act of 2009 (ARRA). The 2010 TRA extends the 2010 provisions through 2012, including the individual child credit of $1,000 and the lower $3,000 threshold for the refundable credit.

• A Dependent Care Credit may be claimed for an applicable percentage of qualifying care expenses paid for children under 13 and disabled dependents in order for the taxpayer to work. The 2010 TDA extends through 2012 the amounts of eligible expenses of $3,000 for one child and $6,000 for two or more children at the applicable percentage of 20-‐35 percent depending upon adjusted gross income..

• Earned Income Tax Credit. This credit is available to certain low-‐income taxpayers, who qualify based on their earned income, adjusted gross income, number of children, and filing status. For 2009 and 2010, the ARRA increased the credit to 45% of the first $12,590 of earnings for taxpayers with three or more qualifying children. The credit is phased out at higher earnings levels. The 2010 TRA extends the refundable Earned Income Tax Credit of 45% and the higher phase-‐out threshold for married taxpayers filing jointly through 2012.

• Energy Credits. The American Recovery and Reinvestment Act of 2009 (the Stimulus Act – ARRA) provided a non-‐refundable tax credit for specified energy-‐efficient improvements

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installed in the taxpayer’s principal residence in 2009 and 2010. The new law extends the credit to include nonbusiness energy property placed in service on or before December 31, 2011, then credit rates, dollar limits, and lifetime limits revert back to the less-‐favorable levels in effect prior to 2009.

• Adoption Credit. Individuals who adopt an eligible child are entitled to claim an income-‐tax credit for qualified adoption expenses, up to $13,170 per child for 2010 and $13,360 for 2011. The credit phases out for higher income taxpayers. These higher credit limits were established by the Patient Protection and Affordable Care Act of 2010. The 2010 TRA extends the credit through 2012, but at the lower levels in place before 2010. The corresponding benefit allowing the exclusion from income of adoption expenses paid by an employer was also extended through 2012.

Education Incentives. The new law extends several education-‐related tax benefits. In some cases, they are retroactive.

• The American Opportunity Tax Credit (AOTC), which replaced the Hope Scholarship credit, was scheduled to expire at the end of 2010. The AOTC allows a credit for each eligible student of up to $2,500 per year for up to four years of undergraduate education, but is subject to phase out for higher income taxpayers. The 2010 TRA extends the AOTC for the 2011 and 2012 tax years.

• Coverdell Education Savings Accounts (ESAs) are tax-‐exempt savings accounts used to pay the higher education expenses of a designated beneficiary. The ESA per beneficiary contribution limit of $2,000 and other enhancements, which were scheduled to end after 2010, have been extended to the end of 2012.

• Qualified Tuition Deduction. The deduction from gross income of up to $4,000 for individual taxpayers whose adjusted gross income is $65,000 or below (up to $2,000 for AGI between $65,000 and $80,000 certain higher income taxpayers) for qualified post-‐secondary education tuition and related expenses expired at the end of 2009. The new law reinstates and extends the deduction for 2010 and 2011.

• Student Loan Interest Deduction. Certain favorable features of this allowable deduction from gross income for higher-‐education student loan interest of up to $2,500 a year, including higher income limits before the deduction is phased out, were to end after 2010. The 2010 TRA temporarily extends the expanded student loan interest deduction through 2012.

• Employer Education Assistance. The 2010 TRA temporarily extends the provision allowing an employee to exclude from gross income up to $5,250 per year of employer-‐provided undergraduate and graduate education assistance through 2012.

• Income Exclusion for Qualified Scholarships. Previous legislation allowed certain scholarships for tuition and related expenses to be excluded from income for income tax purposes. The 2010 TRA extends these provisions for 2011 and 2012.

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Part 3 Changes Affecting Businesses

Changes Affecting Businesses Some significant changes have been made by the Tax Relief Act of 2010 (2010 TRA) to provide and extend incentives for investment in machinery and equipment and increase business activity. Many of these will be advantageous to small business operators, including farmers and ranchers. Extension of Investment Incentives Business operators generally deduct the costs of machinery, equipment, or structures, which have a useful life of more than a year, through depreciation. For income tax purposes, the depreciation for most business and investment property is calculated using the Modified Accelerated Cost Recovery System (MACRS).8 In addition to the MACRS depreciation, business owners may elect to deduct additional depreciation in the year the property is purchased to save taxes and thus, provide an incentive for such investments. Two different elections are available. The first is called the “Section 179 Expensing Election” and the second is “Bonus Depreciation” or additional first-‐year depreciation. These two elections can also be combined in some situations. The bonus depreciation can be claimed after any section 179 expense deduction and before figuring the regular depreciation under MACRS. Remember, these are elections; taxpayers may opt to forego these additional first-‐year deductions and stay with the MACRS. The only requirement is that for first-‐year bonus depreciation, all assets in the same property class must be treated the same. For Section 179 expenses, each asset can be handled differently. Section 179 Expensing Election. Businesses have the option of taking an immediate deduction in the year of purchase for all or some of the cost of tangible personal property in lieu of depreciation. The purchased property may be new or used, but in the case of a trade-‐in (like-‐kind exchange) only the “boot” paid is eligible for expensing. This Section 179 election was expanded by the Small Business Jobs Act of 2010 (SBJA), signed into law on September 27, 2010. The 2010 SBJA increased the maximum amount a taxpayer may elect to expense to $500,000 in 2010 and 2011 (previously $250,000). This maximum amount is reduced dollar-‐for-‐dollar when the amount of qualifying property placed in service during the year exceeds $2 million (previously $800,000). The 2010 SBJA also added off-‐the-‐shelf computer software as qualifying property for 2010 and 2011.9 Keep in mind that the amount of Section

8 The MACRS calculations are explained in the Farmer’s Tax Guide, published by the IRS, chapter 7. http://www.irs.gov/pub/irs-‐pdf/p225.pdf 9 The amount deducted as a Section 179 expense in a tax year may not exceed the taxable income of the trade or business. The amount not allowed as a deduction because of the taxable income limitation may be carried forward.

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179 deduction claimed, if any, reduces the property’s basis for purposes of regular depreciation deductions in subsequent years. The 2010 TRA sets the maximum amount of qualifying property purchases a taxpayer may expense under Section 179 to $125,000 (indexed for inflation) for the 2012 tax year. This amount is reduced dollar-‐for-‐dollar when the amount of qualifying property placed in service during the year exceeds $500,000. The TRA also extends the definition of off-‐the-‐shelf computer software as qualifying property through 2012. After 2012, the maximum amount that can be expensed drops to $25,000 with reductions beginning when the total cost of qualifying property placed in service during the year exceeds $200,000. Table 5. Changing Provisions for Section 179 Expensing and Bonus Depreciation Options Year Max Sec. 179 Deduction Sec. 179 Purchase Limit 1st Year Bonus Depr. 2009 $250,000 $800,000 50% 2010 $500,000 $2,000,000 50%/100%a 2011 $500,000 $2,000,000 100% 2012 $125,000 $500,000 50% 2013 $25,000 $200,000 50%b

a The deduction is 50% for purchases before 9/9/2010 and 100% for those made 9/9/2010 and after. b The 50% bonus is extended through 12/31/2013 for certain property with a recovery period of 10 years or longer and certain transportation property, defined as tangible personal property used in the trade or business of transporting persons or property.

50% and 100% Bonus Depreciation Options. Under the prior law, additional or bonus depreciation was allowed in the first year for qualified property. This bonus depreciation was equal to 50% of the adjusted basis of the property and allowed for both regular tax and AMT purposes. Among the requirements to qualify for bonus depreciation are that the property must be new; it must be MACRS property with a recovery period of 20 years or less; and it must be purchased and placed in service during the relevant time period. In the case of trade-‐ins (like-‐kind exchanges), the bonus depreciation can be claimed on the entire basis (the remaining depreciation or book value of the relinquished property plus the “boot” paid). Any first-‐year bonus depreciation claimed reduces the property’s basis for purposes of regular depreciation deductions in subsequent years. The 2010 TRA extends and expands the first-‐year bonus depreciation (Table 5): • The first-‐year depreciation options are expanded by allowing businesses a depreciation deduction of

up to 100% of the cost of qualified new (not used) property acquired and placed in service from September 9, 2010, through December 31, 2011(with an extension of one year for certain longer-‐lived and transportation property10). The new law does not place a dollar limit on the amount of qualified property eligible for the 100% write-‐off.

10 This includes certain property with a recovery period of 10 years or longer and certain transportation property, defined as tangible personal property used in the trade or business of transporting persons or property.

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• For property placed in service after December 31, 2011, and through December 31, 2012, the 2010 TRA extends the 50 percent first-‐year bonus depreciation option. The 50% bonus depreciation will also apply to certain long-‐lived and transportation property placed in service in 2013.

Some special constraints apply to the first-‐year bonus depreciation option: 1. All property in the same class (3-‐year property, 5-‐year property) must be treated the same way.11

The taxpayer may either claim bonus depreciation for all 3-‐year property purchased during the year or for none of it. For example, if bonus depreciation is claimed for a new truck, which is 5-‐year property, purchased in 2011, then bonus depreciation must be used for all 5-‐year property placed in service that year.

2. If the taxpayer claims bonus depreciation, it will be either 50% or 100% depending on when the property was purchased. Assets purchased from September 9, 2010, through December 31, 2011, in the same property class must take 100% – the choice is 0 or 100% for each class. Before September 9, 2010, and after December 31, 2011, the choice is 0 or 50%.

Comparing the Section 179 Expense and Bonus Depreciation Options. Several factors should be considered in deciding whether or not to elect one or both of these options and if so, when. • Depending on the size of the eligible purchases, these deductions could be potentially large resulting

in a significant reduction in taxable income. That may work well in a year when net income is expected to be high, but may not be as advantageous in a less prosperous year.

• The timing of the purchases will affect the amount of the tax benefit. Property purchased in 2011 is eligible for 100% bonus depreciation, but for property purchased in 2012, it will be 50%. The maximum deduction for Section 179 expense is $500,000 in 2011, $125,000 in 2012, and $25,000 after 2012.

• The amount of the Section 179 deduction cannot exceed the taxable income from the taxpayer’s trades and businesses. Any excess deduction above the trade or business taxable income can be carried over and deducted in the next year subject to certain Section 179 limits. The first-‐year bonus depreciation in excess of taxable income, however, creates a net operating loss, which can be carried back to previous tax years or forward.

• The amount of the Section 179 expense that can be deducted is reduced if the total cost of qualifying property purchased exceeds $2,000,000 in 2011 and $500,000 in 2012.

• What types of property will be purchased? Some items, like machinery sheds, shops, and general purpose farm buildings (tangible property with a MACRS depreciable life of 20 years or less and that meet certain requirements), are eligible for bonus depreciation, but not Section 179 expensing.

• Only property purchased new is eligible for the first-‐year bonus depreciation. Both new and used is eligible for Section 179 Expensing.

11 The nine typical property classifications are (1) 3-‐year property, (2) 5-‐year property, (3) 7-‐year property, (4) 10-‐year property, (5) 15-‐year property, (6) 20-‐year property, (7) 25-‐year property, (8) residential rental property, and (9) nonresidential real property.

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• If the property is acquired through a trade (like-‐kind exchange), only the boot portion is eligible for Section 179 expensing. The entire adjusted basis of property acquired through trade-‐in is eligible for the first-‐year bonus depreciation.

• If the property qualifies for both options, both can be claimed with the bonus depreciation taken after the Section 179 expensing.

• If several assets are being purchased during the tax year that fall in the same MACRS class, remember that they must all be treated the same with respect to the first-‐year bonus depreciation. Each asset can be treated differently, however, for Section 179 expensing.

These depreciation options do not increase the total deductions over time. They simply accelerate the cost recovery, moving the deductions to an earlier year and leaving smaller deductions in later years. The enhanced cash flow from the tax saving can be advantageous for paying off any loans or making investments. Accelerating the depreciation, however, will reduce deductions in future years, which may mean result in higher taxable incomes.12 Impact of Depreciation Options on AMT. In general, taxpayers must refigure depreciation for purposes of computing taxable income for the Alternative Minimum Tax. Important exceptions are provided, however, for the options discussed here: • You do not need to refigure depreciation for the AMT for any part of the cost of any property for

which you elected to take a Section 179 expense deduction. The Section 179 expense deduction is the same for the regular tax and the AMT.

• Likewise, for assets subject to bonus depreciation, the rules are the same for both regular tax and AMT purposes. The 100% and 50% first-‐year bonus depreciation rules apply for both regular tax and AMT purposes. In addition, there is no AMT adjustment with respect to regular MACRS depreciation deductions for the remaining 50% of the cost of property subject to 50% bonus depreciation.

Other Business Provisions Deduction of Health Insurance for Self-‐Employeds. Self-‐employed taxpayers have been able to deduct health insurance premiums for purposes of computing their income taxes for several years. However, the deduction for health insurance was not allowed for the purposes of calculating Social Security and Medicare taxes. Now, effective for 2010 returns, the Small Business Jobs Act of 2010 allows self-‐employed individuals to deduct the cost of health insurance for themselves and their families for the purposes of computing Social Security and Medicare taxes. This provision, however, applies only to the 2010 tax year.13

12 For new passenger automobiles or light trucks purchased for business use, there are limits on the depreciation deductions allowed. See the IRS 2010 Instructions for Form 4562. http://www.irs.gov/pub/irs-‐pdf/i4562.pdf. 13 For more information and an example, go to https://ruraltax.org/htm/se-‐tax.

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Employee Benefits. The following 2010 TRA provisions affect the taxation of benefits provided to employees:

• Under the new law, employers may continue to provide employees up to $5,250 of non-‐taxable educational assistance (including assistance for undergraduate and graduate-‐level courses) through 2012.

• The monthly income exclusion limit for employer-‐provided transit pass and vanpooling benefits will continue to be the same as the limit for parking benefits through 2011.

• The credit for employer-‐provided child care is extended through 2012. This credit is for employer expenses up to $150,000 for acquiring, constructing, rehabilitating or expanding child care facilities.

• Benefits provided under an employer's adoption assistance program are also income-‐tax free up to $13,170 for the 2010 tax year, $13,360 for 2011, and $12,170 for 2012 (adjusted for inflation after 2010). The adoption assistance exclusion is phased out once an employee’s income exceeds a specified level.

Business Credits. The 2010 TRA extends several business tax credits that expired at the end of 2010 or before. Here are some examples:

• The Work Opportunity Tax Credit is extended by four months to apply to wages paid to certain individuals who begin work for an employer between September 1, 2011, and December 31, 2011. This tax credit is equal to 40 percent of the first $6,000 of wages paid to new hires of one of nine targeted groups.

• The Research Credit is retroactively extended for two years, 2010 and 2011. • The Differential Wage Credit (for wage payments to employees serving on active duty in the U.S.

uniformed services) is retroactively restored and extended two years through 2011. • Energy-‐Efficient Appliance Credit with modifications is extended one year for manufacturers and

covers appliances manufactured in 2011. • The Energy-‐Efficient Home Credit (available to contractors that construct qualified new energy-‐

efficient homes and to energy-‐efficient manufactured home producers) is retroactively extended two years for homes sold by December 31, 2011, for use as residence.

• The New Markets Tax Credit for equity investments in a qualified community development entity is retroactively extended for two years through 2011, subject to an annual limitation on the amount of equity investments allowed nationwide.

Provisions Related to Biofuels. The following provisions of the 2010 TRA will be of interest to farmers, ranchers, and producers of biofuels: • The tax incentives (excise tax credit) for alcohol fuel and alcohol mixtures are extended through

December 31, 2011. The cellulosic biofuel producer credit will continue to be available through December 31, 2012.

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• The biodiesel and renewable diesel fuel credits are extended through 2011. These income tax and excise tax credits are now allowed for biodiesel and renewable diesel fuels produced, sold or used on or before December 31, 2011.

• The excise tax credits and refund rules for alternative fuels and alternative fuel mixtures are extended through December 31, 2011.

Contributions of Capital Gain Real Property for Conservation. The 2010 TRA extends the liberalized deduction rules for qualified contributions of capital gain real property for conservation purposes, which were scheduled to expire at the end of 2009. Qualified conservation contributions are charitable donations of real property interests, including remainder interests and conservation easements that restrict the use of real property. The new law retroactively extends for 2010 and 2011 the rules permitting qualified farmers and ranchers to deduct up to 100% of the fair market value of the contribution and to carryover any unused deduction for up to 15 years. Additional Provisions Related to Charitable Contributions. The 2010 TRA extends the following provisions through December 31, 2011: • Taxpayers engaged in a trade or business will be able to continue to claim an enhanced charitable

deduction for food inventory contributions. These are items fit for human consumption contributed to a qualified charity or private operating foundation for use in the care of infants, the ill, or the needy.

• C corporations may claim an enhanced charitable deduction for donations of books to public schools (kindergarten through grade 12).

• Corporations making qualified computer contributions to certain educational organizations or public libraries may claim an enhanced deduction.

• For contributions made by a Subchapter S corporation, the shareholders will reduce their stock bases by their pro rata share of the adjusted basis of the contributed property (even if such deductions would exceed such shareholder’s adjusted basis in the S corporation), rather than the shareholder’s pro rata share of the fair market value of the contributed property.

Extension of small business capital gains exclusion. Small business corporations contemplating the sale of stock have another year, through 2011, to take advantage of a provision that allows non-‐corporate taxpayers who purchase that stock to exclude the gain from its sale if it is acquired at original issue and held five years.14 The Small Business Jobs Act of 2010 (enacted last September) temporarily increased the gain exclusion to 100% (within limits) for sales of qualified small business corporation stock issued after September 27, 2010 and before January 1, 2011.15

14 The 2010 TRA also provides that these excluded gains from selling the stock will not count as an AMT preference item. 15 Qualifying small business stock is from a C corporation whose gross assets do not exceed $50 million (including the proceeds received from the issuance of the stock) and meets a specific active business requirement.

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Accumulated Earnings Tax. The accumulated earnings tax is imposed on regular C corporations that allow earnings and profits to accumulate instead of being divided or distributed to shareholders and subject to income taxes. The 2010 TRA extends the 15% tax rate on accumulated taxable income of C corporations for taxable years beginning in 2011 and 2012. In the absence of this Act, the rate would have been 20%. Recently Added 1099 Reporting Requirements Repealed. Both the Patient Protection and Affordable Care Act of 2010 (PPACA) and the Small Business Jobs Act of 2010 (SBJA) expanded the form 1099 reporting requirements for payments made by businesses and landlords. Because of concerns about the time and costs that this reporting would impose on taxpayers, on April 5, 2011, Congress repealed the provisions of these two laws that imposed these added requirements. However, information reporting requirements are not completely eliminated as the previous reporting requirements in place prior to the 2010 legislation will continue. Taxpayers engaged in a trade or business are still required to provide a Form 1099-‐MISC to every individual payee to whom they made payments for rent, services, or interest totaling $600 or more in any taxable year. Payments to corporations are exempt. If an IRS audit finds that the taxpayer did not file the required forms, the result could be substantial penalties.

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Part 4 Changes Affecting Estates

Changes Affecting Estates For the first time in many years, there was no federal estate tax in 2010, but the tax was scheduled to return in 2011, with higher rates and lower exemptions than those in effect from 2002 through 2009. Now, the Tax Relief Act of 2010 (2010 TRA) has established more favorable estate tax provisions for decedents in 2011 and 2012 and given executors for estates created by deaths in 2010 a choice to make. The estate will be subject to the 2010 TRA provisions, unless they elect to stay with the old law. More on this later. First, the bill makes some significant modifications in the rules for estate taxes, gift taxes and generation-‐skipping transfer taxes. With the 2010 TRA, the tax rates and exemptions for gifts (transfers made while living), estates (transfers made at death), and generation-‐skipping transfers (transfers to a beneficiary who is more than one generation younger than the person making the transfer) are again unified for 2011 and 2012. This means that, with a few exceptions, a single lifetime exemption is used for gifts and/or bequests and the tax rates are the same for these different types of transfers. This reunification is effective for gifts made after December 31, 2010. Exemptions. Individual taxpayers are allowed an exemption (also called an “applicable exclusion amount”) that shelters an aggregate amount of lifetime gifts and transfers at death from estate and gift tax. If the total taxable estate and lifetime gifts are less than or equal to this amount, no federal estate tax will be due. For 2011 and 2012, the lifetime federal gift and estate tax exemption is $5 million – with the 2012 exemption adjusted for inflation. This unified exemption also includes generation-‐skipping transfers. The gift tax exemption for 2010, however, remains at $1 million for 2010. The reunification with the $5 million lifetime exemption is in effect for 2011 and 2012. For decedents dying or gifts made after December 31, 2009, the exemption for generation-‐skipping transfers will be $5 million. The tax rate for generation-‐skipping transfers in 2010 is zero, but will be 35% for 2011 and 2012. Portability of unused exemptions. The 2010 TRA allows the executor of a deceased spouse’s estate to transfer any unused exemption (limited to $5 million) to the surviving spouse’s estate tax exemption (Table 6). This provision is effective for estates of decedents dying in the 2011 and 2012 tax years. This portability provision may allow married couples to pass up to $10 million to their heirs free from estate taxes and is claimed by filing the estate tax return upon the death of the surviving spouse.

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The example in Table 6 illustrates how the unused exemption from the estate of the first spouse to die can be transferred to the surviving spouse’s estate resulting in a combined exemption of $10 million and no estate tax liability. Like so many other aspects of the 2010 TRA, this provision is temporary and both spouses would have to die before the end of 2012 for it to apply.

Table 6. Portability of Exemption Example

First Spouse Dies

Surviving Spouse Dies

Estate value $ 4 million $ 6 million

Exemption $-‐5 million $-‐5 million

Unused exemption $-‐1 million

Transferred exemption $-‐1 million

Taxable estate $ 0 $ 0

Estate and Gift Tax rates. The 2010 TRA sets the tax rate for the estate, gift, and generation skipping transfers to a flat-‐rate of 35 percent on the amounts above the exemption for 2011 and 2012. Table 7 compares the exemptions and rates over time under the prior law and with the 2010 TRA.

Table 7. Estate-‐Tax Rates and Exemption Amounts

Exemption Amount Highest Rate

2009 $3.5 million 45%

Prior Law: 2010 100% 0%

Prior Law: 2011-‐2012 $1 million 55%

New Law: 2010* $5 million 35%

New Law: 2011-‐2012 $5 million** 35%

2013 $1 million 55%

* Unless special opt-‐out election is made ** Subject to inflation adjustment for 2012

For 2011 and 2012, the gift tax exemption is unified with the $5 million estate tax exemption and a gift tax rate of 35 percent. The annual exclusion for gift tax purposes will remain unchanged at $13,000 for individuals. For gifts made in 2010, the gift tax rate is 35%; however, the exemption for gift tax purposes remains at $1 million. Generation-‐skipping transfers (GSTs) involve outright gifts or transfers through trust agreements from the grantor to the grantor's grandchildren, not the grantor's children. By skipping a generation, the grantor’s children avoid estate taxes that would apply if the assets were transferred to them.

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With the 2010 TRA unification, the $5 million exemption and tax rate of 35 percent apply for GSTs in 2011 and 2012 with the 2012 exemption adjusted for inflation. For 2010, the $5 million GST exemption is available regardless of the executor’s election for 2010 estates. Transfers made in 2010, however, will be subject to a zero GST tax rate. Thus, gifts to grandchildren made in 2010 will incur no current GST tax. In addition, future distributions to the grandchild from such a trust created in 2010 can also be made free of the GST tax. Modified Carryover Basis versus Stepped Up Basis. The Economic Growth Tax Relief Reconciliation Act of 2001 (EGTRRA) completely repealed the estate tax for the 2010 tax year and replaced it with what is referred to as the modified carryover basis rules. So instead of the estates resulting from deaths in 2010 being subject to estate taxes, the heirs would be subject to higher capital gains taxes as a result of the carryover basis. Prior to 2010, property passing through an estate received a stepped up basis. Under this rule, the cost basis of the property inherited by the heirs is the fair market value of the property on the date of death. With the stepped up basis, the heirs can sell the property with the likelihood of little or no capital gains tax. With the carryover basis, however, the cost basis of the property passing to the heirs is the same as the decedent’s basis.16 For example, if Frank inherited property from his father, for which his father paid $29,000 in 1946, Frank’s basis would be $29,000 even though the current market value might be over $1,000,000. Obviously, this represents a potentially large capital gain for the heir, which would be subject to income tax upon sale of the property. In many cases, the historical records are not available to determine the carryover basis, resulting in a default basis value of zero. For 2010 estates, the carryover basis of the decedent is modified for the heir. The executor is allowed to increase basis by $1.3 million. If the estate is going to the spouse, the basis can be increased by an additional $3 million for a total of $4.3 million. However, the amount of the basis cannot be increased above the fair market value of the property. The 2010 TRA generally repeals the modified carryover basis rules that were in effect for property inherited from a decedent who died in 2010 and reinstates the stepped up basis rules for estates in 2011 and 2012 and as an option for 2010. This means that property inherited from a decedent will receive a stepped-‐up basis (fair market value at date-‐of-‐death) under the rules applicable to 2009 estates. In the case of the estate created as a result of death in 2010, this will depend on the executor’s decision as discussed in the next section.

16 More precisely, the carryover basis is the lesser of the fair market value of the decedent's property on the date of death or the decedent's original income tax basis in the property plus the value of certain improvements.

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Special provisions for deaths in 2010. The 2010 TRA estate tax provisions are retroactive to January 1, 2010, reinstating the estate tax with the $5 million exemption and 35% estate tax rate. The Act, however, allows an election (revocable only with IRS approval) to choose no estate tax and modified carryover basis for estates created by deaths in 2010. The executors of estates of individuals who died in 2010 have two options:

1. Take advantage of the $5 million exemption, 35% rate, and stepped up basis for income tax purposes, or

2. Use the old 2010 rules with no estate tax and apply the modified carryover basis to calculate income taxes when the inherited property is sold.

For the executor of a large estate with several heirs, this is a complex decision depending on the type of property going to each heir, if or when the heirs plan to sell their inherited properties, and the projected capital gains upon sale. What is best for one heir may not be best for the others. This election is the executor’s decision, and although it would be best if all heirs concurred in the decision, this may not always be possible. The law also provides the heirs of decedents, who die in 2010 before the enactment of the new legislation, a nine-‐month extension for filing estate and gift/generation-‐skipping transfer tax returns and paying taxes. Specifically, in the case of a decedent dying after December 21, 2009, and before December 17, 2010, the deadline is extended to September 17, 2011.

recent changes in affecting individuals, part 1 businesses

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