On December 17, the President signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act). The 2010 Tax Relief Act extends for two years the Bush-era tax cuts, retains for two years favorable tax rates for long-term capital gains and qualified dividends, provides significant estate and gift tax relief, and includes a two-year AMT “patch.” It also contains new tax breaks, including 100% first-year write-offs of qualifying property placed in service after Sept. 8, 2010 and before Jan. 1, 2012, and a payroll/self- employment tax cut of two percentage points for 2011 for employees and self-employed individuals. Plus it extends a host of expired and expiring tax breaks for businesses and individuals as well as a number of key disaster relief provisions.
This letter explains how the 2010 Tax Relief Act provides a two-year respite for valuable tax breaks that would have been eliminated after 2010 by sunset rules in EGTRRA, JGTRRA and ARRA. These include a favorable tax rate structure, marriage penalty relief, favorable tax rates for long-term capital gains and qualified dividends, and liberal education-related tax breaks and credits. It also explains the Act's new two-year “patch” for the alternative minimum tax (AMT).
Overview of Two-Year EGTRRA/JGTRRA/ARRA Sunset Relief
Under pre-Act law, the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16 ), other than those made permanent or extended by subsequent legislation, were set to sunset and no longer apply to tax or limitation years beginning after 2010. (Sec. 901 of EGTRRA) Beginning in 2011, the EGTRRA sunset would have wiped out a host of favorable tax rules, such as: favorable income tax rate structure for individuals; marriage penalty relief; and liberal education-related deduction rules. Similarly, under Sec. 303 of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA, P.L. 108-27 ), as modified by Sec. 102 of P.L. 109-222, the favorable tax treatment of long-term capital gain and qualified dividends would have ended after 2010.
The alternative minimum tax (AMT) exemption amounts were “temporarily” increased for four years by EGTRRA, and then “temporarily” increased again by a succession of tax laws. The ability of individuals to use most nonrefundable personal credits to offset AMT also is “temporary,” and has been extended over the years by a series of new laws. Under pre-Act law, after 2010, the AMT exemption amounts were to have plummeted to their pre-EGTRRA level, and individuals would not have been able to use most nonrefundable personal credits to offset AMT.
Finally, the American Recovery and Reinvestment Act of 2009 (ARRA, P.L. 1115) temporarily boosted the credit incentives for higher education (i.e., created the American Opportunity Tax Credit, or AOTC), and liberalized the rules for the refundable child tax credit and the earned income tax credit (EITC). Under pre-Act law, these ARRA incentives would have ended on Dec. 31, 2010.
New law. Under 2010 Tax Relief Act Secs. 101 through 103, the Sec. 901 EGTRRA sunset, the Sec. 303 JGTRRA sunset, and the ARRA sunsets relating to the AOTC, child tax credit, and EITC are extended for two years (one year in case of the adoption rules). Thus, all of the favorable tax rules explained below remain in place through 2012.
- Reduced Tax Rates Extended for Two Years
- Increased Standard Deduction Amounts Extended for Two Years
- No 3%/80% Limitation on Itemized Deductions for 2011 and 2012
- No Phase-Out of Personal Exemptions for 2011 and 2012
- Reduced Capital Gains and Qualified Dividends Rate Extended for Two Years
- Withholding and Other Tax Rates Stay Unchanged
The following rates are tied in one way or another to the tax rates for individuals. Thus, although not expressly amended by the 2010 Tax Relief Act, they will remain unchanged for 2011-2012 because the Act extends current tax rates for individuals through 2012. The rates that follow will remain at current levels, instead of increasing under the EGTRRA sunset rule:
- Accumulated earnings tax rate (Code Sec. 532). This rate stays at 15% instead of rising to 39.6%.
- Personal holding company tax rate (Code Sec. 541). This rate stays at 15% instead of rising to 39.6%.
- Minimum withholding rate on supplemental wages under flat rate method (Code Sec. 3402). This rate will stay at 25% instead of rising to 28%. (For supplemental wage payments totaling more than $1 million for a calendar year, the rate stays at 35% instead of rising to 39.6%).
- Backup withholding rate on gambling winnings (Code Sec. 3402(q)). This rate stays at 25% instead of rising to 28%.
- Backup withholding rate on reportable payments (Code Sec. 3406). This rate stays at 28% instead of rising to 31%.
- Voluntary withholding rates on certain federal payments (e.g., Social Security benefits) (Code Sec. 3402).These rates stay at 7%, 10%, 15%, or 25%, instead of rising to 7%, 15%, 28%, 31%.
- Voluntary withholding rate on unemployment benefits (Code Sec. 3402). This rate stays at 10% instead of rising to 15%.
Expanded Child Tax Credit Extended for Two Years
New law. Under Secs. 101 and 103 of the 2010 Tax Reform Act, the $1,000 child tax credit is extended and allowed to be used against regular income tax and the AMT for two years, through 2012. The formula for determining the refundable child credit, with the earned income threshold of $3,000 (but not adjusted for inflation) is extended for two years, through 2012. Also extended for two years is the treatment of the refundable portion of the child tax credit as not constituting income or a resource in determining the eligibility or amount of benefits or assistance under any Federal program or State or local program financed with Federal funds.
Other Incentives Extended Two Years Include:
- Expanded Earned Income Tax Credit Extended
- Expanded Adoption Credit and Employer-Provided Adoption Assistance Extended One Year
- Expanded Employer-Provided Child Care Tax Credit Extended Through 2012
- Expanded Dependent Care Tax Credit Extended Two Years
Numerous Education Incentives Extended Two Years
- American opportunity tax credit.
- Exclusion for scholarships.
- Employer-provided educational assistance.
- Student loan interest deduction.
- Coverdell education savings accounts.
Boosted AMT Exemption Amounts for 2010 and 2011
The alternative minimum tax (AMT) is the excess, if any, of the tentative minimum tax for the year over the regular tax for the year. In arriving at the tentative minimum tax, an individual begins with taxable income, modifies it with various adjustments and preferences, and then subtracts an exemption amount (which phases out at higher income levels). The result is alternative minimum taxable income (AMTI), which is subject to an AMT rate of 26% or 28%.
Under pre-Act law, the AMT exemption amounts for tax years beginning after 2009 were: $33,750 for unmarried individuals; $45,000 for married couples filing jointly and surviving spouses; and $22,500 for married individuals filing separately.
New law. The 2010 Tax Reform Act patches the AMT exemption amounts for 2010 and 2011.
Personal Nonrefundable Credits May Offset AMT and Regular Tax for 2010 and 2011
A number of personal credits are nonrefundable (i.e., the dependent care credit, the credit for the elderly and disabled, the child credit, the credit for interest on certain home mortgages, the Hope Scholarship and Lifetime Learning credits, the credit for savers, the credit for certain nonbusiness energy property, the credit for residential energy efficient property, the credit for certain plug-in electric vehicles, the credit for alternative motor vehicles, the credit for new qualified plug-in electric drive motor vehicles, and the D.C. first-time homebuyer credit).
For taxable years beginning before 2010, the nonrefundable personal credits are allowed to the extent of the full amount of the individual's regular tax and alternative minimum tax. However, under pre-Act law, for tax years beginning after 2009, the nonrefundable personal credits (other than the child credit, the credit for savers, the credit for residential energy efficient property, the credit for certain plug-in electric drive motor vehicles, the credit for alternative motor vehicles, and the credit for new qualified plug-in electric drive motor vehicles) are allowed only to the extent that the individual's regular income tax liability exceeds the individual's tentative minimum tax, determined without regard to the minimum tax foreign tax credit.
New law. For tax years beginning during 2010 or 2011, the 2010 Tax Relief Act allows an individual to offset his entire regular tax liability and AMT liability by the nonrefundable personal credits. (Code Sec. 26(a)(2) , as amended by Act Sec. 202).