New law extends Bush-era tax rates for two years

After weeks of wrangling over the details, both the Senate and the House passed a bill that will extend the tax rates in effect in 2010 for another two years, through December 31, 2012. President Obama signed the 2010 Tax Relief Act into law on December 17, 2010.

Here’s an overview of the key provisions in the law.

Tax rates. The existing tax rates established in the 2001 and 2003 tax laws will continue for all taxpayers through 2012. This means the top tax rate for 2011 and 2012 will remain at 35% instead of reverting to 39.6% as it would have done had the 2010 Tax Relief Act not passed.

Capital gains and dividends. The top rate for long-term capital gains will remain at 15% for taxpayers in all but the two lowest ordinary income brackets; those taxpayers will continue to have a 0% rate on capital gains. Dividends will continue to be taxed at the 15% and 0% rates instead of reverting to ordinary income rates as high as 39.6%.

Itemized deductions and personal exemptions. Higher-income taxpayers will not have their itemized deductions limited and their personal exemptions phased out.

Education tax breaks. The law extends the American Opportunity Tax Credit through 2012. The income exclusion for up to $5,250 of employer-provided education assistance to employees is continued for two years. The higher contribution limit of $2,000 and other enhancements to Coverdell Education Savings Accounts were extended for two years.

Alternative minimum tax (AMT). The AMT was given another “patch” for 2010 and 2011, a move that will keep the tax from hitting millions more taxpayers. For 2010, the exemption amount is $47,450 for individuals and $72,450 for married couples filing joint returns. For 2011, the exemption is $48,450 for singles and $74,450 for couples. Without this adjustment, the exemption amounts for 2010 and 2011 would have been $33,750 for singles and $45,000 for couples.

Payroll tax. A new tax break is created for workers who pay social security taxes. For 2011, the employee rate for social security tax is cut from 6.2% to 4.2% on wages up to $106,800. Self-employed individuals will pay 10.4% on self-employment income up to $106,800. Employers will continue to pay 6.2% on employee wages. This payroll tax rate cut does not affect the Medicare portion of payroll taxes for either employees or employers.

Extenders. Tax breaks that have come to be called “extenders” because they’re typically extended retroactively every year, but just for a year, are again extended by the new law.

Effective for 2010 and 2011 returns, taxpayers have the option of deducting state and local sales taxes instead of state and local income taxes. The deduction for up to $4,000 of higher education expenses and the deduction for teachers who buy classroom supplies are extended. Those age 70½ or older may again contribute up to $100,000 tax-free from an IRA to a charity. Note that the deduction for real estate taxes paid by nonitemizers was not extended.

Business provisions. The law extends the research tax credit for 2010 and 2011, and it extends the work opportunity tax credit through 2011. Bonus depreciation is increased from 50% to 100% for qualified business purchases made from September 9, 2010, through December 31, 2011. 50% bonus depreciation will be available in 2012.

Estate tax. The estate tax was perhaps the most contentious issue in the law, and it came close to unraveling the deal. The compromise that was agreed upon restores the estate tax retroactive to January 1, 2010, and continues it through December 31, 2012. It establishes a top rate of 35% and an exclusion amount of $5 million ($10 million for married couples). Estates of persons who died in 2010 have the option of applying the estate tax and receiving a step-up in basis on property passing to heirs or having no estate tax but using a carryover of the decedent’s basis in property.

The 2010 Tax Relief Act also provides an additional 13 months of benefits to the unemployed.

Mark these tax deadlines on your 2011 calendar

It’s time to file various tax returns once again. Among the tax deadlines you may be required to meet in the next few months are the following:

January 18 – Due date for the fourth quarterly installment of 2010 estimated taxes for individuals unless you file your tax return and pay any taxes due by January 31.

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Be careful with joint property and ‘payable on death’ accounts

If you intend to leave your children equal shares of your estate, don’t forget to consider any money or property held jointly with a child. If you have recently added a child to a bank account, own property jointly with one of your children, or have set up a payable-on-death account with a child as the beneficiary, you might want to revise your will, or at least reconsider how the asset is titled.

Here’s why: Property in a joint account passes outside of your estate. If you add a child to one of your bank accounts, perhaps as a convenience because the child is helping to manage your finances, the account will pass to that child alone when you die. This is true for any property held in joint tenancy, or any property in a payable-on-death account. [Read more…]

There may be better alternatives to charitable gifts in your will

Many people include charitable gifts in their will. Not only do they want to help certain charities, but doing so can reduce estate taxes. But suppose that at some point, it becomes clear that your estate will likely incur little or no estate tax. You might consider removing all or part of such a bequest from your will, and instead making a gift while you’re still alive. Doing so could give you a large income tax deduction, while having no effect on your estate tax – leaving more assets for your heirs.

You might also want to amend your will and your power-of-attorney document so that if you become unable to manage your affairs, your agent can “pre-pay” a charitable bequest while you’re still alive in order to save taxes in this way. [Read more…]

Return of estate tax creates a danger for life insurance policies

With the federal estate tax now back in effect – and the possibility that it will apply to estates as small as $1 million at some point in the next few years – many people need to take a second look at their life insurance policies.

Life insurance proceeds are not subject to income tax. But what many people don’t realize is that if you own your life insurance policy, then the proceeds will be considered part of your estate when you die. If those proceeds – combined with your other assets – amount to more than the estate tax exemption, then your estate may be subject to estate taxes.

If the beneficiary of your policy is your spouse (and your spouse is a U.S. citizen), then no estate tax will be due at the time of your death. However, the proceeds will now be part of your spouse’s estate when he or she dies, and will be subject to estate taxes then.

What many people don’t realize is that if you own your life insurance policy, then the proceeds will be considered part of your taxable estate when you die.

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The federal estate tax is back in 2011

The federal estate tax is back in effect as of January 1, 2011.

As a result of a last-minute compromise in Congress, the estate tax will be temporarily reduced for two years. In 2011 and 2012, the tax will apply to estates over $5 million, at a rate of 35%. However, unless Congress changes the law again, after 2012 the tax will apply to any estate over $1 million, at a rate of 55%.

As a result, the estate tax is no longer a problem just for the rich. A huge swath of the middle class could now be affected if, at some point in the next few years, the value of their house, their retirement savings and the proceeds of their life insurance tops $1 million.

In addition, many states have their own estate taxes and their own rules, and these can be less generous than the federal rules in some ways.

That makes it critically important to plan your estate – or re-evaluate your estate plan – if you haven’t already done so.

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