Business Tax Changes in the 2010 Tax Relief Act

Several generous business tax cuts were contained in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (TRA), enacted on December 17, 2010.  Those of particular note are:

• Bonus Depreciation.  Under the Small Business Jobs Act of 2010 (SBJA), the old 50% bonus depreciation that had expired after 2009 was extended to qualifying property placed in service through 2010.  The TRA increases the percentage to 100% of the cost of qualifying assets placed in service from September 9, 2010 through December 31, 2011.  The TRA also extends the 50% bonus depreciation to assets placed in service during 2012.  No bonus depreciation applies after 2012 (except for certain long-term production-period property).  Unlike the Section 179 expensing election, bonus depreciation applies to all sizes of businesses and can create a net operating loss that can be carried back to refund taxes paid in prior tax years.  However, bonus depreciation only applies to "new" property, whose original use starts with the taxpayer.  As an additional benefit, property for which bonus depreciation is claimed is not subject to the alternative minimum tax depreciation adjustment.  Qualifying property typically consists of machinery, equipment, other tangible personal property, most computer software, and certain leasehold improvements.  A taxpayer may elect not to claim bonus depreciation in those cases where it might not prove beneficial.  Note that bonus depreciation is determined upon the placed in service date whereas Section 179 expensing is determined upon taxable years.
• Section 179 Expensing.  Under the SBJA, the amount of qualifying property that could be expensed was raised to $500,000 for assets placed in service during tax years beginning in 2010 and 2011.  The $500,000 is reduced dollar for dollar as the amount of total qualifying property exceeds $2 million in the taxable year.  Qualifying property typically consists of new or used personal property and software; but for tax years beginning in 2010 and 2011, a special rule permits certain purchases of qualified real property to be included, up to $250,000 of the $500,000 limit.  The TRA retains these amounts for tax years beginning in 2010 and 2011 and changes (with inflation adjustments) the expensing limit to $125,000 and the start of the phase-out to $500,000 for tax years beginning in 2012.  However, the TRA did not extend the special qualified real property expensing provision past 2011.  For tax years beginning after the 2012, the limitations will be $25,000 and $200,000 respectively.  With 100% bonus depreciation available for assets placed in service through 2011, Section 179 expensing will not prove as useful except for "used" property for which bonus depreciation is not available.
• Research and Experimental Tax Credit.  The TRA retroactively extends the research tax credit that had expired at the end of 2009 until the end of 2011 for amounts paid or accrued.  For eligible small businesses, important changes were made by the SBJA such that, for tax years beginning in 2010, the research tax credit is not limited to the excess of regular tax over AMT and any unused 2010 research credit may be carried back five tax years instead of one.  An eligible small business is (1) a corporation the stock of which is not publicly traded, (2) a partnership, or (3) a sole proprietorship, if the average annual gross receipts of the business for the three-tax-year period preceding the 2010 tax year does not exceed $50 million.
• 15-Year Depreciation of Qualifying Leasehold Improvements.  The special 15-year (instead of 39-year), straightline depreciation method available for qualifying leasehold improvements, qualified restaurant property, and qualified retail improvements, was extended to such property placed in service through 2011.  In addition, this property may also be eligible for the special Section 179 expensing provisions for qualified real property (discussed above).

Estate Tax Provisions, 2010 through 2012

The 2010 Tax Relief bill enacted on December 17, 2010, contained dramatic estate, gift, and generation skipping transfer tax (GST) changes for the years 2010 through 2012, decreasing such taxes by $68 billion.  The so-called "Bush tax cuts" of 2001 increased the exemption from estate tax and lowered the tax rate over the years to 2009, and then provided for no estate or GST tax in 2010 (although gift tax continued to apply).  With the scheduled "sunset" of the tax cuts, the former higher estate tax rules would return in 2011.  Given the dramatic whip-saw effect of the changes, observers were shocked to see that Congress did not act to reform the estate tax prior to 2010.

The new tax law retroactively reinstates the estate tax to January 1, 2010 and provides an enhanced exemption of $5 million and a lowered tax rate of 35% through 2012.  The so-called "step-up in basis rule," which permits the income tax basis of non-income-with-respect-to-a-decedent property to be adjusted to fair market value as of the date of death, is also retroactively reinstated and the modified carryover basis regime repealed.  However, for deaths occurring in 2010, the executor of the estate may elect out of these new rules and instead apply the zero estate tax rate and modified carryover basis rules that previously applied.  For 2010 estates smaller than $5 million, the retroactive extension of the estate tax should be beneficial because of the full step-up in tax basis provision.  For very large 2010 estates, electing out of the estate tax and becoming subject to the modified carryover basis regime is probably best.  Careful analysis is necessary to decide which rules to follow for 2010 estates greater than $5 million and less than perhaps $40 million.

The lifetime gift tax exemption remains at $1 million for 2010 but is then re-unified with the estate tax exemption of $5 million beginning in 2011.  The GST exemption amount for 2010 through 2012 is increased to $5 million but the tax rate remains at 0% for 2010, increasing to 35% in 2011 and 2012.

A 2010 estate tax return (Form 706) is now required for gross estates above $5 million.  The normal due date of 9 months following the date of death has been extended to be no earlier than 9 months following the date of enactment, for deaths occurring January 1, 2010 through December 17, 2010.  If the executor elects out of the estate tax for 2010, then the modified carryover basis disclosure (Form 8939) must be filed by that date.

A major change in the new law is the so-called "portability" of the estate tax (and gift tax by reason of "unification") exemption between spouses, for deaths occurring in 2011 and 2012.  However, the GST exemption is not portable.  The deceased spouse's estate must file an estate tax return to claim the portability benefit.  Portability helps to solve the vexing problem of wasting a portion of the estate tax exemption if one spouse does not separately own property worth at least as much as the estate exemption.  Any unused estate exemption of the first spouse to die may be carried over to the surviving spouse.  In the case of multiple spouses, only the unused exemption of the last spouse to die may be used.  A person cannot accumulate unused exemptions from multiple spouses who die!  Does portability eliminate the need for credit-shelter or family trusts?  Such trusts might not be needed for federal estate tax in 2011 and 2012, but with multiple marriages and litigation in today's society, these trusts will still prove to be very useful even if not needed for federal estate tax planning.  Also, this portability provision is only temporary and ends after 2012.  The uncertainty surrounding the estate tax has not been solved by this new law, and you must still consider what the law might be after 2012 in your planning!

With the "reunification" of the gift and estate tax exemptions, taxpayers who have previously used up their $1 million lifetime gift tax exemption will be able to make significant new gifts in 2011 and 2012.

Estate tax planning provisions in your existing wills and trusts that rely on formula provisions to fund the credit shelter or family trust should be reviewed.  The provisions were written when the exemption from estate tax was much smaller.  For example, in 1999 the exemption was only $650,000; now it is $5 million through 2012.  The increase in the federal exemption changes how the estate property will be inherited among your beneficiaries and may not reflect your intentions.  Credit shelter trusts often put restrictions on how much the surviving spouse may benefit from the trust, and in some cases, may totally exclude the surviving spouse.  The temporary change in law does not mean credit shelter trusts are no longer necessary, it means that you may wish to consider limiting how much goes into the credit shelter trust and/or to add provisions enabling your surviving spouse to more easily benefit from the trust.

Certain proposed adverse changes to estate planning techniques were not included in the new law.  The proposal to require GRATs to have a 10-year minimum term (among other requirements) and the proposal to eliminate some valuation discount opportunities were not included.

Last minute 2010 transfer tax planning primarily concerns GST planning.  Consider implementing before 2011 the following:

• Make direct-skip gifts to grandchildren or to a GST-trust for the exclusive benefit of grandchildren and further descendants.  Be careful to avoid making gifts above the amount of your unused $1 million lifetime gift tax exclusion or else a gift tax of 35% will be incurred even though the GST tax rate is 0% in 2010.
• Make distributions to grandchildren from trusts that are not exempt from GST (zero-inclusion ratio).

The following table summarizes the transfer tax exemptions and rates for 2009 through 2013.

Year	2009	2010	2011	2012	2013
Estate exemption	$3.5M	$5.0M	$5.0M	$5.0M*	$1.0M
Estate tax rate	45%	35%	35%	35%	55%
Gift exemption	$1.0M	$1.0M	$5.0M	$5.0M*	$1.0M
Gift tax rate	45%	35%	35%	35%	55%
Gift annual exclusion	$13K	$13K	$13K	$13K*	$13K*
GST exemption	$3.5M	$5.0M	$5.0M	$5.0M*	$1.0M*
GST tax rate	45%	0%	35%	35%	55%

* As indexed for inflation

Major Tax Changes for 2011 and 2012

Pres. Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 on December 17, 2010.  Over 10 years the Act cuts taxes by $801 billion, with a $917 billion reduction during 2011-2013 followed by $116 billion of offsetting tax increases during the latter years.  Another $56 billion is spent on an extension of unemployment insurance benefits.  Working on the federal budget deficit was evidently a problem for another day!  The Act essentially extends the so-called "Bush tax cuts" for two more years, pushing off the problem of increasing tax rates until the end of 2012, a presidential election year!  In addition to income tax cuts, the Act makes major cuts to the estate tax in 2011 and 2012 ($68 billion) and to Social Security taxes on employees in 2011 ($111 billion).  Significant business tax cuts were also enacted as well as an extension of so-called "tax extenders."  The tax extender provisions had expired at the end of 2009, and so the two-year extension only takes these provisions through 2011 instead of 2012.  This article will focus on individual tax cut extensions and other articles will address business and estate tax provisions.

Significant ordinary income and capital gain tax rate cuts were enacted in 2001 and 2003 along with enhanced tax deductions and credits.  Due to Senate budgetary rules, the cuts were designed to expire ("sunset") at the end of 2010.  Most observers believed at the time that the problem of expiring tax cuts would be addressed before the end of 2010.  Now the problem has been procrastinated to the end of 2012.  In 2013 the former higher tax rates return and, in addition, the tax increases of ObamaCare begin.  In short:

1. The ordinary tax rates of individuals remain at 10%, 15%, 25%, 33%, and 35% in 2011 and 2012 for all taxpayers, not just those earning less than $250,000 ($200,000 for single taxpayers) as originally proposed by the President.
2. The ordinary tax rates of trusts and estates remain at 15%, 25%, 28%, 33%, and 35% in 2011 and 2012.  The 10% rate has never applied to trusts and estates.
3. The long-term capital gain and qualifying dividend tax rates remain at 0% for taxpayers in the 10% and 15% ordinary income rate brackets, and 15% for those in higher ordinary rate brackets, in 2011 and 2012.  The current 28% and 25% capital gain rates for collectibles and unrecaptured real estate depreciation remain unchanged.
4. The elimination of the reduction to itemized deductions and personal exemptions based upon AGI levels, reached for the first time in 2010, continues in 2011 and 2012.
5. The enhanced American Opportunity Tax Credit (formerly the HOPE credit) for college costs continues for 2011 and 2012, permitting a credit of up to $2,500 (with income-based limitations) for four years of college education.
6. The exemption from alternative minimum tax is increased to $72,450 and $47,450 for joint and single filers in 2010.  The exemption increases to $74,450 and $48,450 respectively in 2011.  For 2012, Congress will again need to "patch" the AMT exemption amount to prevent over 20 million more taxpayers from becoming subject to the AMT.  The cost of patching the AMT is becoming very expensive because the AMT is essentially an upper-middle class tax.  This provision alone cuts taxes by $137 billion.
7. The employee 6.2% Social Security tax rate will be reduced to 4.2% in 2011 only.  The employer's share of the tax will remain at 6.2%.  The additional 1.45% Medicare portion of the FICA tax will remain the same and continues to be assessed on all compensation.  This provision replaces the Making Work Pay Credit that applied only to lower income earners.  The 2% rate reduction also applies to self-employment tax.  Changes are made to the calculation of the deductible percentage of self-employment tax in order for the full cost of the "employer match portion" of the self-employment tax to be deductible in 2011.
8. The election to deduct state and local sales tax in lieu of state income tax is extended to 2010 and 2011.
9. The ability to make direct, tax-free traditional IRA distributions to public charities is extended to 2010 and 2011.  The extension will qualify any 2010 charitable transfers made before enactment of the Act.  Direct charitable transfers count towards fulfilling the annual minimum required distribution.  While the transfer reduces adjusted gross income, there is no charitable itemized deduction (which would otherwise be a double benefit).  This provision continues to be limited to taxpayers age 70 1/2 or older and may not exceed $100,000 in a tax year.  Because this provision was extended so late in the year, a special election permits a charitable distribution made during January 2011 to be treated as if it had been made on December 31, 2010 for purposes of the annual $100,000 limitation and for purposes of meeting the 2010 minimum required distribution.
10. The residential energy tax credit is extended through 2011.  However, the extension uses the old pre-2009 rules of a $500 lifetime limit and a credit percentage of 10% of costs instead of the $1,500 lifetime limit and percentage of 30% of costs that applied during 2009 and 2010.  If you have already claimed credits of $500 or more in the past, no further credit is available.

Charitable IRA Transfer Proposal

Prior law permitted taxpayers age 70 1/2 or older to make tax-free distributions from their IRA (limited to $100,000 each year) directly to public charities.  This transfer counted as part of the taxpayer's required minimum distributions.  As a result, the taxpayer's adjusted gross income (AGI) was lowered by the direct transfer to charity.  A lower AGI can reduce the portion of Social Security benefits subject to income tax, and also permit additional medical expenses to become deductible.  The trade-off was the loss of the itemized charitable deduction for the direct transfer, but with lower AGI, the charitable deduction was in effect transferred to an "above-the-line" deduction.

Current tax law proposals will extend the charitable IRA transfer provision retroactively to the beginning of 2010 and through 2011.  An interesting feature of the proposal is that taxpayers may elect to treat transfers made in January 2011 as if made in 2010 for purposes of the annual $100,000 limit, and importantly, as part of their 2010 required minimum distribution amount.  The January 2011 feature is necessary because Congress is waiting until the last days of 2010 to extend the tax law, and taxpayers are unsure of what to do.

An alternative to waiting is to make the direct charitable IRA transfer now.  If the law is extended retroactively, it will include the transfer made before enactment of the extension.  If the law is not extended, then the charitable distribution is taxable, but it will be offset by the charitable itemized deduction.  I do not advise making charitable IRA transfers in excess of the required 2010 minimum distribution amount until an extension of the provision is actually enacted.

Deficit Commission Final Report Released

The National Commission on Fiscal Responsibility and Reform, appointed by Pres. Obama, adjourned on December 3, 2010, with only 11 of 18 members voting to recommend the final report. Fourteen votes were necessary to send the report to Congress for legislative action.  While the report was ominously titled, "The Moment of Truth," it will sit on the shelf gathering dust.  Parts of the report may be used or referred to in future presidential budget recommendations and in future legislative squabbles.

A few items to observe from the final report that are in addition to my November 12th blog include:

• Capital gains would be taxed at ordinary rates
• State and municipal bond interest would be taxable
• All retirement accounts would be consolidated and tax-preferred contributions capped at the lower of $20,000 or 20% of income.

Interesting 2010 Tax Return Due Dates

While we wait for our elected national leaders to do something responsible with our 2010 and 2011 tax laws, let's look ahead to some interesting 2010 tax return due dates.

Even though April 15, 2011 falls on Friday, the due date for filing 2010 federal individual income tax returns is Monday, April 18, 2011.  So I will lose another weekend to tax season!  The due date is delayed because Friday, April 15^th is Emancipation Day, a legal holiday in Washington, DC.  The various states will have their own due dates.  Utah’s due date will follow the federal due date.  The April 18^th due date is also effective for filing Form 4868 for an automatic six-month extension.  The extended due date is October 17, 2011, because October 15^th falls on Saturday.

New for 2010 Utah partnership tax returns, the six-month extension period has been shortened to five months.  So the extended Utah partnership due date is now September 15, 2011 instead of October 17, 2011.  This change conforms the Utah partnership extension due date to the federal due date, which was previously shortened to five months for 2009 partnership tax returns.

Note that even though the federal trust tax return extension period was shortened to five months beginning with 2009 trust tax returns, Utah’s trust tax return extension period remains at six months for 2010 trust tax returns.  Also, no changes have been made to federal or Utah corporation tax return due dates.