Individual Tax Updates

Lower Tax Rates Extended through 2012. The Act extends the 10%, 15%, 25%, 28%, 33%, and 35% federal income tax rates on ordinary income through 2012. Without the new law, these rates would have been replaced in 2011 and beyond by the pre-Bush rates of 15%, 28%, 31%, 36%, and 39.6%. The Act also extends the 0% and 15% federal income tax rates on most long-term capital gains and dividends through 2012. Without the new law, most long-term capital gains would have been taxed at 10% or 20% and dividends would have been taxed at ordinary rates of up to 39.6%.

Marriage Penalty Relief Extended through 2012. As you know, getting married can cause a couple's combined federal income tax bill to be higher than when they were single. The 2001 Bush tax cut legislation eased this marriage penalty by tweaking the lowest two tax brackets for married couples and by giving them bigger standard deductions. Without the new law, these fixes would have disappeared after 2010. The Act extends them through 2012.

Social Security Tax Reduction for 2011 Only. The Act cuts the 6.2% Social Security tax withholding rate on employee salaries from 6.2% to 4.2%. This temporary change only affects the first $106,800 of 2011 wages (i.e., wages up to the 2011 Social Security tax ceiling). The maximum savings are $2,136 for unmarried individuals and $4,272 for couples. The Social Security tax component of the self-employment tax is cut from 12.4% to 10.4% for 2011, so self-employed folks will benefit too.

Good News: Because of this change, employees should notice bigger paychecks by the end of January, if not sooner. Self-employed folks will account for the change by reducing their 2011 estimated payments.

Personal Exemption and Itemized Deduction Phase-outs Repealed through 2012. For 2010, unfavorable phase-out rules that could reduce some of your most-cherished write-offs were temporarily repealed. The phase-out rules were scheduled to come roaring back in 2011. Thankfully, the Act keeps the repeal in place through 2012.

Alternative Minimum Tax (AMT) Patch for 2010 and 2011. As you know, it has become an annual ritual for Congress to "patch" the AMT rules to prevent millions more households from getting socked with this add-on tax. The patch primarily consists of allowing bigger AMT exemptions and allowing personal tax credits to offset the AMT. The Act makes the patch for 2010 and for 2011 as well.

100% Gain Exclusion for Qualified Small Business Corporation Stock Extended to Cover Shares Issued in 2011. The Small Business Jobs Act of 2010 (enacted last September) created a temporary 100% gain exclusion (within limits) for sales of qualified small business corporation (QSBC) stock issued between 9/28/10 and 12/31/10. The Act extends the window for taking advantage of this change by one year to cover QSBC shares issued between 9/28/10 and 12/31/11. Note: QSBC shares must be held for more than five years to be eligible for the gain exclusion break. Thus, we are only talking about sales that will occur well down the road.

IRA Qualified Charitable Contributions Extended through 2011. For 2006-2009, IRA owners who had reached age 70 1/2 were allowed to make annual tax-free distributions of up to $100,000 paid directly out of their IRAs to charitable organization. These donations are called qualified charitable distributions (QCDs). They generally do not directly affect your federal income tax bill because no deductions are allowed. However, you do not have to itemize deductions to benefit and QCDs count as IRA required minimum distributions (RMDs). Therefore, charitably inclined seniors can get a break by arranging for tax-free QCDs to take the place of taxable RMDs and those who do not itemize can effectively get the benefit of the deduction by arranging for tax-free QCDs. The QCD break expired at the end of 2009. The Act retroactively restores it for 2010 and extends it through 2011. Note: If you are interested, you still have time to take advantage of the QCD opportunity for the 2010 tax year. That's because you can make an election to treat QCDs taken during January of 2011 as 2010 QCDs that count as part of the 2010 $100,000 QCD limit and 2010 RMDs (to the extent you've not already taken your RMDs for 2010). Any other QCDs taken in 2011 will be treated as 2011 QCDs that count as part of the 2011 $100,000 QCD limit and 2011 RMDs (up to your RMD amount for 2011). Please contact us if you are considering QCDs.

Bigger Child Credit Extended through 2012. For 2011 and beyond, the maximum credit was scheduled to drop from $1,000 to only $500. The Act extends the $1,000 credit through 2012.

American Opportunity Education Credit Extended through 2012. The American Opportunity credit can be worth up to $2,500, can be claimed for up to four years of undergraduate education, and is 40% refundable. It was scheduled to expire at the end of 2010 and be replaced by the Hope Scholarship credit which is smaller, can only be claimed for the first two years of college, is subject to phase-out at lower income levels, and is nonrefundable. The Act extends the more generous American Opportunity credit through 2012.

College Tuition Deduction Extended through 2011. This write-off, which can be as much as $4,000, or $2,000 at higher income levels, expired at the end of 2009. The Act retroactively restores the deduction for 2010 and extends it through 2011.

More Generous Student Loan Interest Deduction Rules Extended through 2012. This write-off, which can be as much as $2,500 (whether you itemize or not), was scheduled to fall under less favorable rules in 2011 and beyond. The Act extends through 2012 the more favorable rules established by the 2001 Bush tax cut legislation.

More Generous Coverdell Education Savings Account Rules Extended through 2012. For 2011, the maximum contribution to federal-income-tax-free Coverdell college savings accounts was scheduled to drop from $2,000 to only $500, and a stricter phase-out rule would have limited contributions by many married joint-filing couples. The Act extends through 2012 the more generous contribution rules established by the 2001 Bush tax cut legislation.

Employer Educational Assistance Plans Extended through 2012. Through 2010, an employer can provide up to $5,250 in annual federal-income-tax-free educational assistance to each eligible employee. Both undergraduate and graduate school costs can be covered by the plan, and the education need not be job-related. This taxpayer-friendly deal was scheduled to expire at the end of 2010. The Act extends it through 2012.

Option to Deduct State and Local Sales Taxes Extended through 2011. For the last few years, individuals who paid little or no state income taxes had the option of claiming an alternative itemized deduction for state and local general sales taxes. The sales tax deduction option expired at the end of 2009. The Act retroactively restores it for 2010 and extends it through 2011.

More Generous Earned Income Tax Credit Rules Extended through 2012. The 2009 Stimulus Act increased the refundable earned income credit (EIC) percentage for families with three or more qualifying children from 40% to 45%. This change was effective for 2009 and 2010, and it resulted in larger EICs for affected families. The Stimulus Act also increased the income threshold for the phase-out rule that can reduce or eliminate EICs for married joint-filing couples. Both changes were scheduled to expire at the end of 2010. The Act extends them through 2012.

More Generous Dependent Care Tax Credit Rules Extended through 2012. For the last few years, parents could claim a credit of up to $600 for costs to care for one under-age-13 child or up to $1,200 for costs to care for two or more under-age-13 kids, so the parents can go to work. Lower-income parents can claim larger credits of up to $1,050 and $2,100, respectively. For 2011 and beyond, the maximum credits were scheduled to drop. The Act extends the more generous maximum credit amounts through 2012. Note that in some cases, the credit can also be claimed for dependents other than under-age-13 children.

Smaller Tax Credit for 2011 Energy-efficient Home Improvements. The 2009 Stimulus Act provided that 30% of 2009 and 2010 expenditures for energy-efficient insulation, windows, doors, roofs, and heating and cooling equipment in U.S. residences could qualify for a credit, up to a maximum credit amount of $1,500 over the two years combined. The new law extends the credit through 2011, but the credit percentage is scaled back to only 10% and the lifetime credit limit is only $500. The $500 credit cap is reduced by any credits claimed in 2006-2010.

$250 Deduction for K-12 Educators Extended through 2011. For the last few years, teachers and other eligible personnel at K&-12 schools could deduct up to $250 of school-related expenses paid out of their own pockets—whether they itemized or not. This break expired at the end of 2009. The Act retroactively restores it for 2010 and extends it through 2011.

Bigger Tax-free Limit for Employer-provided Transportation Fringes Extended through 2011. The 2009 Stimulus Act increased the maximum monthly amount that an employee can receive as a tax-free fringe benefit for employer-provided transit passes and/or employer-provided transportation in a commuter highway vehicle (van pooling) to equal the maximum monthly tax-free amount for employer-provided parking benefits. As a result of the increase, the maximum monthly tax-free amount that could be received in 2010 for transit passes and/or van pooling (together or separately) was $230. However, the increased limit expired at the end of 2010. The new law extends the increased limit for transit passes and/or van pooling through 2011. The IRS just announced that the 2011 tax-free monthly limit for transit passes and/or van pooling is $230 (same as for 2010).