Here are key points of the tax deal that was signed into law December 17, 2010.
Income tax rates
What happens to income tax rates?
For the next two years (2011 and 2012) they remain as they were, for all income levels, except for the usual inflation adjustments. The highest rate stays at 35%.
Does this deal block the return of rules that phase out personal exemptions and itemized deductions for higher-income taxpayers?
Yes. These provisions, often called “stealth taxes,” were eliminated for 2010 but scheduled to return in 2011. Now they’ll be scheduled to return in 2013, along with the higher tax rates.
How about the capital gains rate?
This also will remain unchanged.
Qualified dividends?
Ditto.
Social security tax break
So no changes in tax rates?
Not exactly. The payroll tax rate will be reduced by two percentage points, only for 2011.
How does that work?
The money withheld from your paycheck normally includes 6.2% that goes to social security. Your employer has to match that with another 6.2% and send a total of 12.4% to the IRS. For 2011, your share is reduced to 4.2%. (Your employer will still have to pay 6.2%.) If you earn $50,000, your take-home pay will go up by $1,000.
How does that affect my social security benefit when I retire?
It doesn’t.
What if I’m self-employed?
You’ll see a corresponding reduction in your self-employment tax.
Alternative minimum tax (AMT)
What happened to AMT?
Here again, the status quo is preserved for two years. The difference is that the two years of AMT relief in this law cover 2010 and 2011, not 2011 and 2012. The numbers for the AMT exemption amount, as provided in the pending law, are available in our Reference Room.
Then what happens in 2012?
Barring an earthshaking even, such as major tax reform, we’ll likely see the usual political dance around the issue of how (or whether) to pay for another year of AMT relief.
Other goodies
What happens to other expiring tax benefits?
Most of the usual “extenders” are extended two years. These include items such as the itemized deduction for state and local sales tax and the above-the-line deduction for qualified tuition and related expenses. Various expiring tax provisions for businesses are extended as well.
Some benefits were allowed to expire, however. The Making Work Pay Credit, designed to reduce the burden of social security tax on workers with moderate income, was replaced with the reduction in social security tax described above. And non-itemizers lose the ability to deduct a portion of their real property tax.
How about tax benefits Obama added in 2009?
Also extended two years are Obama’s expansions of the education credit (American Opportunity tax credit), the child tax credit and the earned income credit.
Estate tax
What happens to the estate tax?
It returns, but with a larger exclusion amount ($5,000,000) and lower rate (35%) for the next two years. After that the exclusion amount would shrink and rates would go up unless Congress acts again. Also included are rules allowing you to use the unused estate tax exclusion of a deceased spouse, and allowing full use of the estate tax exclusion against gift tax (not just the first $1,000,000, as under prior law).
1099 Reporting
Wasn’t Congress supposed to repeal the burdensome law that vastly expands Form 1099 reporting of payments between business?
That’s how it looked, but as of now repeal of this unpopular provision has not found its way into this legislation.
This article has been changed since the original posting to add the Q&A about stealth taxes and the paragraph describing certain benefits that were allowed to expire.
Are the phaseouts removed for itemized deductions and exemptions for 2011 and 2012?
Good question, so I added it to the post above as the second question. The repeal of these “PEP” and “Pease” phaseouts is extended for two years. Generally, except for estate tax and AMT (which receive separate treatment as described above), everything in the 2001 tax act that was subject to expiration is extended two years.
Is there any change to the $13,000 permitted as a tax-free gift to anyone?
The annual gift tax exclusion remains unchanged. It would continue to be adjusted for inflation, but due to low inflation it will remain at $13,000 for 2011.
DId they extend the energy saving credits – new furnaces, windows, etc, which were to expire Dec. 31st?
What about the Retirement Savers Contribution Credit? Is that renewed for 2011 and 2012?
The retirement savings contribution credit was previously made permanent, in the Pension Protection Act of 2006, so further extensions are not required.
I believe the pre-tax transit deduction increase was extended 2 years as well. You should mention that in your Q&A (assuming I am correct.)
Enhanced transportation fringe benefit rules that were set to expire at the end of 2010 were extended, but only for one year.
The credit for “nonbusiness energy property” was extended for one year, but with a return to the levels we had prior to the enhancements in the 2009 Recovery Act. A number of other changes were made in the rules, so anyone who hasn’t yet qualified for the credit on a planned purchase that won’t qualify under the 2011 rules (or will produce a smaller credit) had better act fast.
“… non-itemizers lose the ability to deduct a portion of their real estate tax, AT LEAST IN THIS VERSION OF THE LAW. “
Is there another version of the law under consideration at this point (12/21/10) that would re-instate this?
We’ve updated the main article to remove the words “at least in this version of the law.” The article was first posted when it was possible that the Senate version of the law would be changed in the House, but the House ended up accepting the Senate version without changes.
In 2010 they eliminated the $100k income ceiling for Roth Conversions. Am I correct in thinking that there is still no income ceiling for future Roth IRA Conversions?
Elimination of the $100,000 ceiling on Roth conversions is permanent. The only thing special about 2010 is the option to defer the income instead of reporting it in the year of the conversion.
Kay,
If the elimination of $100L ceiling for Roth conversion is permanent, it doesn’t make any sense to have an AGI limit for Roth contribution. Can’t I just contribute to a non-deductible, traditional IRA, and the next day convert it to Roth? Can’t I do this every year?
Then why the AGI limit for Roth contribution?
Nothing under present law would prevent someone with income above the Roth contribution limit from doing as you suggest, contributing to a traditional IRA and converting the next day to a Roth. If you have an existing traditional IRA you are not looking to convert at the same time, you would have to deal with the tax consequences of the aggregation rule, however.
For example, suppose you have a $45,000 traditional IRA with zero basis and you want to get $5,000 into a Roth this year. If you’re allowed to make a deductible contribution to a traditional IRA you’re all set: contribute to the TIRA, claim the deduction, then convert $5,000 with the tax on that amount being offset by the deduction for the contribution. If your TIRA contribution is nondeductible, though, your conversion will produce taxable income of $4,500 even if your contribution went to a separate TIRA that was subsequently converted. You have to aggregate your traditional IRAs in determining the tax consequences of a conversion, and in this example your aggregate would be 10% basis and 90% pre-tax.
This stumbling block affecting some taxpayers isn’t enough to justify this situation as a truly logical one, but I haven’t seen any proposals to go the next step and eliminate the income limitation on contributions to Roth IRAs.
Kay,
Thanks for the explanation.
I converted my previously existing traditional IRAS (non-deductible contributions) in January 2010, to Roth. So my spouse and both now have only Roth IRAs. Also, an active 401k for me (active, meaning working and contributing); spouse’s 401k is inactive (she contributed until mid 2009, and has been out of work force and hence not contributing anymore.
So, we can each contribute $5,000 to a new non-deductible IRA, then convert to Roth within a few days. Then repeat it in future years. Sounds like this is legit, and OK.
Thanks.
Are phase-outs of AMT exemptions for AMT income above certain levels also eliminated for 2010, 2011 and 2012 (similar to the elimination itemized deduction and personal exemption phase-outs for high AGI levels)?
The AMT exemption amount continues to be phased out as always. And, by the way, AMT relief covers only two years, 2010 and 2011. This assures that the issue will come up again in 2012, an election year.