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.