Q&A on the Tax Deal

December 10, 2010

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.