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The Christmas Tax Act

In the midst of all the hustle and bustle of the Christmas and New Years holidays, Congress passed and the President signed the 2010 Tax Relief Act.

Generally, the tax rates and rules that we had for 2010 were extended another two years through the end of 2012.  There are exceptions, however, as well as winners and losers as a result of the law change.  In this Tax Alert, we'll touch on a handful of the more important provisions.

Tax Rates and Capital Gains
The tax brackets will remain unchanged from 2010 into 2011 and 2012.  That means we will continue to have a 10% tax bracket on the low end, and a top tax bracket of 35%, instead of 39.6% as previously scheduled.

Qualified dividend income and long-term capital gains will continue to be subject to a maximum tax rate of 15%.  In addition, the 0% tax rate on long-term capital gains for taxpayers in the two lowest income tax brackets (10 & 15%) will continue to apply through the end of 2012.

IRA Transfers to Charity
In a surprising move, Congress decided to extend the opportunity for IRA owners who are age 70 1/2 or better to make direct trustee-to-trustee transfers of donations to charity.  The maximum amount that can be transferred is $100,000 per year, and the amount transferred counts towards achieving your required minimum distribution for the year.

Because the Tax Relief Act was passed so late in the year, a special provision was added to encourage these types of donations.  Direct transfers made during the month of January 2011 can, at the taxpayer's election, be deemed as if they were made as of December 31, 2010.  So if you did not already use up your $100,000 limit for 2010, you still have time to do so.  In addition, the transfer will also count towards meeting your 2010 required minimum distribution, if so elected.

FICA Tax Reduction
For wages paid during 2011, most employees will see larger paychecks.  The reason for that is a reduction in the Social Security tax withholding from 6.2% to 4.2%.  That drops the FICA withholding rate (combination of Social Security and Medicare taxes) from 7.65% to 5.65%.

All employees qualify for this rate reduction.  Employers, however, will still need to pay in their full 7.65% share.

This reduction also translates into a lower self-employment tax for sole-proprietors and independent contractors.  For income earned during 2011, the tax rate will drop from 15.3% to 13.3%. 

Bonus Depreciation and Section 179
These two provisions are of particular importance to business owners.  Generally when businesses purchase equipment, computers and furniture (also known as "fixed assets"), these items have to be depreciated over a 5 to 7 year period.

For purchases after September 8, 2010 and through December 31, 2011, bonus depreciation at a rate of 100% will apply.  That means a business purchasing most types of fixed assets will be allowed to expense them in full, rather than spreading the cost over a number of years.

There is no dollar amount limitation on the amount of bonus depreciation that can be claimed by a taxpayer.  One major restriction, however, is that bonus depreciation cannot be claimed with respect to the purchase of USED items.  It can only be claimed on purchases for which the business is the original user.

Section 179 also allows a business to expense most types of fixed assets and can be claimed on purchases of both new and used items.  Section 179 is limited to $500,000 in 2010 and 2011 and is limited to a business's net profit for the year. 

Certain leasehold improvements made after 9/8/10 through 12/31/11 can also be expensed rather than being depreciated over 39 years.  To qualify, the improvement must be made to a nonresidential building that has been in service for more than three years.  The deduction can be claimed by the landlord, the tenant or a subtenant, depending on who is actually paying for the leasehold improvement.  Expenditures to enlarge a building, to improve common areas or to install elevators or escalators do not qualify for this expensing provision.

Residential Energy Tax Credits
The tax credits for making energy improvements to your home like windows, doors and insulation have been severely curtailed starting in 2011.  For the past several years, these types of improvements were eligible for a 30% income tax credit to a lifetime maximum of $1,500.  Starting in 2011, the credit rate drops to 10% and the lifetime cap drops to $500.  Even worse, the $500 lifetime cap is measured starting in 2001.  So if you made improvements in the past that resulted in aggregate tax credits of $500 or more, you are out of luck.


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