Congress returns to work in mid-September to a full agenda of tax legislation, dominated by the fast-approaching expiration of the 2001 individual marginal income tax rate reductions. Predicting when Congress will act on the rate cuts or any legislation is nearly impossible. House Democrats, who have already passed a number of tax bills, appear to be allowing the Senate to take the lead in the weeks preceding the November elections. The uncertainty over the fate of many tax provisions makes year-end tax planning more important than ever.
Individual tax rates
For many taxpayers, the greatest uncertainty is over the fate of the 2001 individual income tax rate reductions. After December 31, 2010, the individual marginal income tax rates for all taxpayers will rise when the reduced rates expire. President Obama has asked Congress to extend all of the 2001 individual marginal income tax reductions except for the top two rates.
Change is coming regardless of whether Congress approves the president's proposal or allows the reduced rates to expire entirely. The likely prospect of higher income tax rates significantly impacts tax planning for individuals and business owners.
Individuals may benefit from many traditional planning techniques. Individuals expecting to be in a higher tax rate in a future year because of higher income levels may want take into account the timing of income or deductible expenses in one tax year or another. An individual may find that accelerating income into 2010, so it is taxed at a lower rate, may be advantageous. You may be able to accelerate payments due to you. Another strategy may be to take withdrawals from retirement savings, either as part of a Roth IRA conversion plan or otherwise, to accelerate income into 2010. Similarly, deferring deductions into 2011 may help offset income that is expected to be taxed at a higher rate. You may consider holding off on a charitable contribution until 2011. Our office can help you design a strategy that works best for you.
Individuals in the highest tax brackets also should consider the likely reinstatement of the limitation on itemized deductions. For 2010 - and 2010 only - the limitation on itemized deductions for higher income taxpayers is completely repealed. The provision limits the total amount of otherwise allowable itemized deductions for higher income taxpayers. President Obama has asked Congress to allow the limitation on itemized deductions to return but to modify it for 2011 and beyond.
Also expiring after December 31, 2010 are reduced capital gains and dividends tax rates. For 2010, the maximum capital gains and dividends tax rate is 15 percent (zero percent for taxpayers in the 10 and 15 percent brackets). President Obama has asked Congress to impose a 20 percent capital gains and dividends tax rate on higher-income individuals for 2011 and beyond. All other taxpayers would pay capital gains and dividends taxes of 15 percent unless they qualify for the zero percent tax rate. Generally, the 20 percent tax rate would apply to individuals with incomes over $200,000 and married couples filing a joint return with incomes over $250,000.
The House and Senate have tried several times this year to send a small business tax relief bill to the White House but have failed. House-passed bills stalled in the Senate. The stalemate in the Senate may break this fall because lawmakers are eager to show voters they support "jobs" bills.
Some of the small business tax relief measures that enjoy bipartisan support are:
--Expansion of the small business stock exclusion to 100 percent; --Reform of the Code Sec. 6707A penalties for reportable transactions; --An increase in the deduction for qualified start-up expenses; --Enhanced Code Sec. 179 expensing; and --Bonus depreciation.
The popular first-time homebuyer tax credit (and the reduced credit for long-time residents) has expired. The credit was popular because Congress made it fully refundable and certain lenders allowed purchasers to monetize the credit toward a down payment. Recent reports about sales of new homes reaching record lows may encourage Congress to consider extending the incentive. However, Congress must find a way to pay for the credit if it decides to extend it.
Nine years ago, Congress repealed the federal estate tax. Because of budget concerns, Congress delayed full repeal until 2010. For individuals dying in 2010, the traditional stepped-up basis rules are replaced with a modified carryover basis regime. Again, because of budget concerns, full repeal expires after December 31, 2010. If Congress takes no action on the estate tax before year-end, the exemption level will be $1 million in 2011 and the maximum estate tax rate will be 55 percent.
The House has approved legislation to make permanent the estate tax rules as they were in 2009. The House bill has languished in the Senate over not only its cost but also concerns over whether to make it retroactive to January 1, 2010. Some states have already passed bills to protect older wills based on formula dispositions, which may not have anticipated repeal of the estate tax in 2010.
A package of tax extenders has stalled in the Senate and is unlikely to pass as a single bill because of its price tag. Instead, Democratic leaders in the Senate have indicated that they may enact some of the extenders in other bills, especially the extenders that have support from both parties. House Democrats would prefer the Senate keep the extenders in one bill but will likely acquiesce in enacting some of the extenders rather than none.
Among the extenders that enjoy bipartisan support are:
--Research tax credit; --State and local sales tax deduction; --Teachers' classroom expense deduction; --Higher education tuition deduction; and --Energy incentives for consumers.
Congress must find offsets to pay for any tax cuts and its options are dwindling. Two House-approved revenue raisers, a change in the tax treatment of carried interest and the imposition of self-employment taxes on service S corps, died in the Senate and are unlikely to be revived. Less controversial are reforms to grantor retained annuity trusts (GRATs) and the cellulosic biofuel credit. Congress could also abolish the Code Sec. 199 production activities deduction and raise taxes on oil and gas producers.
Lawmakers have a short window in which to try to pass critical tax bills before year-end. Our office will keep you posted of developments. Please contact our office if you have any questions.
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