21 Jan 2011 Tax Law Changes
TAX CHANGES THAT MAY AFFECT YOU IN 2011
There are a host of tax changes that started in 2011 as well as unanticipated extensions of some tax breaks. The first change was a non-change. All of the tax brackets were scheduled to increase. However, for both 2011 and 2012 they essentially were left alone. In fact, they increased the exemptions a bit due to inflation, which might actually lower your income taxes slightly. In addition, there were a lot of other changes that you should be aware of:
Estate Tax Changes
1. Many wills will need revamping: For at least the next two years, both you and your spouse will each receive an increased exemption from estate tax of 5 million dollars. This is a BIG deal since it is much bigger than the anticipated 1 million that was scheduled for 2011. Moreover, the top rate was reduced from the anticipated 55% of all your assets in the estate to only 35%.
What this means to you: If you have parents whose total assets are over 1 million dollars, or if your total assets (net of liabilities) exceed this amount, this could be a huge bonanza for your family and/or you. It would also mandate changes in your will if you set up marital trusts using the maximum prior exemption, which was 1 million.
In effect, with proper planning, couples can exclude up to 10 million dollars in assets from the estate tax. This is a BIG deal for those of you with moderate estates and really does necessitate a trip to the lawyer to review both your wills and any trusts that you set up.
2. Portability of the exclusion: Congress finally did something good with the estate tax. If your spouse doesn’t use the full 5 million dollar exemption, the unused portion can be used by the surviving spouse in addition to their own 5 million dollar exemption.
Example: John dies in 2011 with a taxable estate of 3 million dollars. Since there is a 5 million dollar exclusion, there is no estate tax due; however, John’s estate only uses 3 million of the 5 million dollar exclusion because John’s estate only totaled 3 million. If an election was made on John’s estate tax return to permit John’s wife, Lori to use John’s unused applicable exclusion amount. Lori’s new exclusion amount will be the 5 million dollar normal exclusion and 2 million more that was unused by her spouse’s estate.
3. If you had a relative die in 2010, you get some juicy tax choices: In 2010, there was no estate tax. However, Congress retroactively reinstituted it with only a 1 million dollar exemption. In order to be fair, Congress gave all estates a choice. They could be subject to the estate tax or they could avoid it altogether. Why would you want to be subject to the tax? The answer is that all assets included in the estate get a “stepped up” basis. This means that the heir’s basis for gain or loss is the fair market value at the date of death. If the estate tax doesn’t apply then the basis is the original cost basis of the person who died.
Example: John’s mom passes away with an estate of $800,000. It consisted of an old house, whose basis was $40,000, now worth $400,000 at the date of death of his mom and some stock who basis was $50,000 and a fair market value of $400,000 at the time of death of his mom. Because of the 1 million dollar exemption, John’s mom’s estate pays no estate tax. However, because it was included in the estate tax return, John gets a step up in basis to the full fair market value of $400,000 for both the stocks and the real estate. If John decided to elect out of the estate tax, he still wouldn’t have paid any estate tax, but his basis would have been the original basis of his mom, which was $90,000.
What this means to you: If you would not owe much estate tax then it probably pay to file an estate tax return and include all the assets of the deceased on the return. If, however, the assets substantially exceed the 1 million dollar exemption (net of liabilities), you probably should elect out of the estate tax in 2010.
4. Reinstatement of installment payment of estate tax: If the deceased had one or more business interests that totaled more than 35% of the total estate value, as much as $476,000 in taxes can be deferred, and IRS will only charge 2% on the deferred tax.
5. Gift tax yearly exclusion remains at $13,000 per person. If you are married, you both can give away $26,000 per person, per year.
Example: Sandra is a single mom with three kids. She can give each kid up to $13,000 per year worth of cash or property with no gift tax.
In addition, there was a lifetime exemption of 1 million dollars in addition to these annual gifts. Sadly for 2011, these numbers were unchanged despite changes in the estate tax exemption.
1. Self employed can no longer use health insurance premiums as a deduction to computing self employment tax. This is one of the few negative tax changes. In 2010, you were able to deduct your health insurance premiums as any other expense in calculated your net income for self employment. This helped reduce your social security and Medicare taxes. Starting in 2011, self employed premiums or health insurance policies for you and your family will NOT be a deduction in computing net income for social security and Medicare. It will, however, be deductible in computing adjusted net income for income tax purposes.
What this means to you: This is a bit of extra confusion that Congress instituted. You can deduct health insurance premiums made for you and your family in computing adjusted gross income, which essentially means you can deduct your health insurance premiums for income tax purposes. However, for social security and Medicare, these same premiums are not deductible.
2. Your vehicle mileage allowance was slight increased. In 2010, you were allowed to deduct 50 cents a mile for business using the IRS method. In addition, you were allowed 14 cents per mile for charitable work and 24 cents per mile for medical and moving. In 2011, you get 51 cents per minute for each business mile, 14 cents per mile for charity and 19 cents per mile for medical and moving. Yes, you read this correctly. The medical and moving mileage deduction decreased.
What this means to you: The slight increase for business mileage shouldn’t affect you since you should probably NOT be using the IRS method anyway for many people.This is an overlooked deduction. When you incur some charitable work such as a mission or other charitable work, you should be claiming 14 cents per mile.
3. 100% bonus deprecation for new equipment: This seems too good to be true. If you buy new equipment for your business, you get to deduct 100% of the business use as long as it has a useful life of less than 20 years.
What this means to you: Most new office equipment such as printers, computers, phone systems, cell phones, monitors, desks, chairs, etc. will garner you a 100% write off. In addition, all software that is used in business is also fully deductible. This is one of those “WOW” changes in the tax law that applies to equipment purchased in 2011 and 2012. If you want to really take a bite out of your taxes, buy a bunch of equipment.
Mark’s Elaboration: You can deduct the cost of new equipment used in business even if you financed the equipment. You don’t need to pay all cash for these items.
4. 100% bonus deprecation for certain vehicles: In addition to being able to deduct all of your new equipment used in business, you can deduct 100% of the business use of certain cars. Which cars qualify? I’m glad you asked. The new vehicles that qualify for this 100% write off are:
a. New SUVs with a gross vehicle weight of over 6,000 pounds
b. New vans and trucks with a gross vehicle weight of over 6,000 pounds
5. $500,000 election for used equipment: If you buy certain used equipment, you can elect to deduct up to $500,000 of equipment that is new to you. It doesn’t have to be new. It just has to be new to you. Thus, it can be used equipment. Also, you can’t have purchased over $2,000,000 of equipment in one year. What qualifies for the $500,000 write off are as follows:
a. Used pickup trucks with a 6 foot or bigger cargo area and a gross vehicle weight of over 6,000 pounds
b. Used vans with a gross vehicle weight of over 6,000 pounds
Mark’s elaboration: I should note that used SUVs with gross vehicle weights of over 6,000 pounds are subject to a $25,000 expense election plus depreciation, all of which isn’t as good as the other vehicles mentions above. As good as some of these rules are, it does make me wonder why a “heavy metal” monster truck or SUV give you a 100% write-off, but a gas saving Honda would only be deductible over 10 years or more. What was Congress thinking?
6. Lower employee share of social security: Normally social security costs are split with the employer paying half (6.2%) and the employee paying the other half, which is 6.2%. Self employed taxpayers pay the same thing. In 2011, the employee portion is reduced by 2% to only 4.2%. Thus, the total SECA tax (Social Security plus Medicare) rate is reduced for 2011 from 15.3% to 13.3% on the first $106,800. On $100,000 of earnings, this is a savings to you, in your pocket, of $2,000.
7. Don’t forget the possibility of the Small Business Health Care Tax Credit: Starting in 2010 and thereafter, you can get a maximum 35% tax credit on health insurance premiums paid by eligible small businesses and 25% tax credit paid by eligible tax exempt organizations. This credit will rise to 50% in 2014. The maximum credit is available to small firms with 10 or fewer employees and only if their average wage is $25,000 or less. The credit is completely phased out for employers that have 25 or more full time employees or that have average wages of $50,000 or more. In addition, part time workers can count as a partial full time worker. Moreover, in computing the average income, at least the owner’s salary doesn’t count in the computation. However, for self employed businesses, health premiums paid for the owner do not qualify for the credit.
8. Small business stock exemption extended through December 31, 2012. I think it may surprise many of you to know that if you sell stock in a regular corporation that you owned for five years or more that has gross assets of less than 50 million, you could avoid up to 75% of the gain on the sale of that stock! Now, if you buy small business stock during 2011 and hold it five years, you can avoid 100% of the gain. Thus, what is small business stock?
To qualify as “qualified small business stock”:
● You must invest in stock of a C corporation
● 80% of its assets must be used in the active conduct of a trade or business, and
not investment assets
● The stock must be held for more than 5 years
● The amount that can be excluded is the greater of 10 million dollars or 10 times
your original cost basis.
● Any taxpayer other than another C corporation can take advantage of the exclusion. Thus, the exclusion can be used by you, your trust, or your estate or your partnership or LLC.
Mark’s elaboration: If you already have a C corporation, you might want to contribute more money in exchange for new stock issued this year! If you hold this stock for over 5 years, you can avoid 100% of the gain on the sale of the stock.
Personal Tax Changes
1. Bush tax cuts were reinstated. Congress reinstated the Bush tax cuts for both 2011 and 2012. This means that the tax rates stayed the same. In fact, due to inflation, Congress has somewhat widened the tax brackets to result in a slightly lower amount of tax than you would have paid on the same income in 2010.
2. Dividend tax rate stays the same as 2010. In 2009-2010 and now through 2012, Congress created a major loophole in the tax law. Qualified dividends are now taxed the same as long term capital gains (certain assets held for more than one year), which is 15%. I don’t care if your name is Trump, you pay a maximum capital gains tax of 15%. What is interesting is that those in the 15% tax bracket or lower, (which applies to single people making less than $34,501 of taxable income and married filing joint folks making less than $69,001) pay zero capital gains tax! You read this correctly.
Mark’s elaboration: This means that if you have an appreciated stock, bonds, mutual fund or real estate, you might want to consider placing the title to these items with lower tax bracketed people that you would support anyway such as your kids, grandkids, parents, sisters, brothers, and significant others, and letting them sell these assets the next day. They are in the zero capital gains bracket, which could allow you to eliminate all of your capital gains taxes!
Additional elaboration: If you are retired, owning stocks that pay dividends becomes an even better deal with this maximum 15% tax rate on dividends.
3. Standard deductions increased. You could hire your kids or grandkids and the first $5,700 that you pay them would be income tax free. For 2011, the standard deduction increased to $5,800.
4. Less beneficial energy credits: In 2010, you were able to get a nice 30% tax credit, up to $1,500 for energy saving items such as storm doors and windows, more efficient heat pumps, etc. In 2011, this credit was reduced to 10% up to $500. There is no change on the 30% credit for solar panels. Thus, if you are thinking of adding solar panels or windmills that generate energy, this would be a good year to do that.
Mark’s elaboration: I honestly don’t understand what Congress is doing. They cut the tax credit for items that reduce energy usage but massively increase the deduction for “heavy metal” vehicles.
5. Higher caps on Series E bonds. Series E bond interest could be tax free if used for qualified education. Although higher income taxpayers get this benefit phased out if they make too much. The phase-out limits for 2011 have slightly increased. This benefit starts phasing out for single tax payers who earn over $71,100 of Adjusted Gross Income (AGI) and is completely eliminated for incomes over $86,100. For those who file “married filing joint returns”, the phase outs begin at $106,650 and complete phase out where the Adjusted Gross Income equals or exceed $136,650.
6. Health Savings Accounts and Flexible Spending account changes to over the counter medication. In 2010, you were able to deduce in your HSA, flexible spending accounts and self insured medical plans most over-the-counter drugs and other items that treated an illness of disease. These include but are not limited to items such as smoke cessation and items that treat weight loss, aspirin, Tylenol, bad aids, vitamins, etc. Starting in 2011, these items are still allowed by these plans; HOWEVER, you will now need a doctor’s prescription in order to cover these over-the-counter items in your Health Savings Accounts, Flexible Spending Accounts and Self Insured Medical Plans.
Mark’s elaboration: As an example, if your doctor wanted you to stop smoking and suggested an over-the-counter treatment, the purchase of this item would be covered by your Health Savings Account, if you got the doctor to give you a prescription for this item.
7. Health Savings Account deductibles and maximum contributions stay the same as in 2010. You must have a high deductible policy for a Health Savings Account of $1,200 for single taxpayers and $2,400 for families. You could contribute and therefore deduct up to $3,050 for singles and up to $6,150 for families in 2010. These numbers stay the same for 2011. In addition, the catch up contribution for those age 55 or over stays the same at $1,000 for each person who attains age 55 or over by December.
8. Roth Conversion tax break changed after 2010. If you converted your IRA or other qualified plan to a Roth IRA, you were able to treat the income from the conversation as being over the next two years. This resulted in a deferral of the tax for up to two years. This benefit has been eliminated. Now you must treat the conversion as taxable in the year of the conversion.
Mark’s elaboration: Frankly, I didn’t like the deferral break anyway since I thought tax rates would be increasing, which didn’t occur yet. If you don’t want to pay tax on the full conversion in one year, consider a partial conversion. If you only convert a portion of your pension plan or IRA to a Roth IRA, only that portion converted would be taxable as a distribution. You can do this over a period of years in order to lessen the tax burden.
9. Larger adoption credit: Thinking of adopting a child? There is a larger credit available for adoption, which is taken on $13,360 of costs. The credit is on the full $13,360 regardless of cost if it involves a special needs child. However, this credit phases out for people who earn over $185,210 of adjusted gross income and completely phases out at $225,210 of AGI. I guess the government doesn’t want rich taxpayers to adopt children.
10. New, onerous information reporting starts this year: If you either have a business or are a landlord, you must now give an IRS Form 1099 to any service provider that you pay $600 or more to. This applies to any contractor even if incorporated. Thus, if you hire a company to repair your properties, you would have to give them a form 1099 if you pay at least $600 during the year. You will need the name of the firm, taxpayer ID and their address. Only landlords with very little rental income are exempt from this; however, IRS has published what this income threshold will be.
Please contact with any questions or comments on this information.