Tax Relief Act of 2010


President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“Tax Relief Act”) into law on December 17, 2010. The Tax Relief Act was designed to extend Bush-era tax cuts while providing other incentives to revive the economy. This is a summary of the most salient tax provisions of the Tax Relief Act:

Estate Tax Provisions

•New Exemption Amounts and Tax Rate. The Tax Relief Act reinstates the estate tax for 2011 and 2012. The new exclusion amount is $5 million for 2011 and is adjusted for inflation in 2012. Absent further legislation, the exclusion will revert to $1 million in 2013. The top estate and gift tax rate is 35 percent in 2010, 2011, and 2012. Again, absent further legislation, the top tax rate will revert to 55 percent in 2013.

•Reunification of Estate, Gift and GST. The Tax Relief Act reunifies the exemption amounts allowed for estate, gift, and generation-skipping transfer taxes at $5 million. This is in contrast to the disparity that existed in 2009 of a $3.5 million estate tax exemption and a $1 million gift tax exemption. Unlike many provisions, the reunification is effective in 2011 and does not sunset.

•Utilization of Exemptions Between Spouses. Historically, every decedent had his or her own exemption amount. If proper planning was not done and the first-to-die spouse did not use his or her full exemption, then the remaining exemption was lost. The Tax Relief Act allows the estate of the second-to-die spouse to use any unused portion of his or her spouse’s exemption. The unused portion must be determined on the first-to-die spouse’s estate tax return. This election is first available in 2011.

•Special Election for 2010. The 2001 Act repealed the estate tax for estates of decedents dying during 2010. The estate tax repeal included a modified, carryover basis for property in the hands of beneficiaries. Prior to the repeal, estates were taxed on the value of assets in excess of the exemption amount and the basis of property received a step-up in basis. Under the Tax Relief Act, the executor of an estate of a decedent dying during 2010 may elect which set of rules to apply. The executor may elect (i) to calculate the estate tax based on a $5 million exemption and a 35 percent top rate, with assets receiving a step-up in basis, or (ii) to pay no estate tax and use a modified, carryover basis for property in the hands of beneficiaries. The election has no effect on the applicability of the generation-skipping transfer tax.

Tax Breaks and Incentives for Individuals

•Retention of Tax Brackets. The Economic Growth and Tax Reconciliation Act of 2001 (“2001 Act”) lowered the individual income tax rates from 15 percent, 28 percent, 31 percent, 36 percent, and 39.6 percent to 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent, respectively. These lowered rates were set to expire at the end of 2010. The Tax Relief Act extends the 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent rates through December 31, 2012.

•Extension of 15 Percent Long-Term Capital Gains Rate. The Jobs and Growth Tax Reconciliation Act of 2003 (“2003 Act”) cut the top capital gains rate from 20 percent to 15 percent. The reduced capital gains rate was set to expire at the end of 2010. The Tax Relief Act extends the long-term capital gains rate of 15 percent through December 31, 2012.

•Extension of 15 Percent Rate on Qualified Dividends. The 2003 Act cut the top individual rate on qualified dividends from 35 percent to 15 percent. The reduced qualified dividends rate was set to expire at the end of 2010. The Tax Relief Act extends the qualified dividend rate of 15 percent through December 31, 2012.

•Payroll Tax Reduction. The Tax Relief Act provides all wage earners (including self-employed individuals) a one-year payroll tax reduction in the amount of Social Security taxes paid in 2011. The Social Security payroll tax will be reduced from 6.2 percent to 4.2 percent for individual wages earned in 2011 up to the taxable wage base of $106,800. The employer’s share of Social Security tax is not affected and will remain at 6.2 percent. Self-employed individuals will pay 10.4 percent on self-employment income up to the taxable wage base of $106,800. The tax reduction will provide a maximum benefit of $2,136 per wage earner.

•AMT Patch. The AMT provisions were originally enacted to make sure that wealthy Americans did not escape paying taxes. However, the AMT has started to apply to more middle-income taxpayers, due in part because the AMT parameters are not indexed for inflation. In recent years, Congress has provided a “patch” to prevent the AMT from encroaching on middle-income taxpayers by raising the AMT exemption amounts.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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