Here are more details of the December 2010 tax legislation, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, including a more in-depth discussion of some of the planning items discussed in the accompanying article.

Businesses Taxes

Small Business Stock. The new law extended enhanced gain exclusion from qualified small business stock to noncorporate taxpayers. For stock acquired after Sept. 27, 2010 and before Jan. 1, 2011, and held for at least five years, the previous law provided an exclusion of 100 percent. The new law extends the 100-percent-gain exclusion for one more year for stock acquired before Jan. 1, 2012.

Effect. While investors need to be patient to take advantage of this benefit (that is, they must hold the qualified shares for at least five years or roll over proceeds into other qualified shares), this is a rare opportunity to potentially exclude from federal income tax millions of dollars of gain on qualifying sales or exchanges of small business stock.

Requirements. The baseline to qualify for the exclusion, includes, among other things, the following:

• The stock must be issued by a subchapter C corporation that invests 80 percent of its assets in the active conduct of a trade or business with assets of $50 million or less when the stock is issued.

• The amount of the exclusion is limited to the greater of
$10 million or 10 times the taxpayer’s basis in the stock.

• Any taxpayer other than a subchapter C corporation can take the exclusion.

Energy Incentives. The authority to provide grants in lieu of tax credits for certain projects is extended for one year, through Dec. 31, 2011. Generally, the property must be placed in service in calendar year 2009, 2010, or 2011. Construction of qualified property must start in that period and be completed before 2013 for wind energy property (or other dates for other types of energy projects).

Requirements. An application for a grant must be made before Oct. 11, 2011.

Depreciation. The election to expense depreciable assets under I.R.C. § 179 has been increased again. But, the most expansive provision for businesses is the bonus-depreciation provision. The new law boosts 50-percent-bonus depreciation to 100 percent for qualified investments made after Sept. 8, 2010 but before Jan. 1, 2012.

• The new law works in concert with the October 2010 Small Business Jobs Act, increasing the I.R.C. § 179 dollar amount and investment limits to $500,000 (for the maximum dollar-amount deduction) and $2 million (for the overall investment in depreciable property) for tax years beginning in 2010 and 2011. After 2011, the new law provides for a $125,000 dollar limit (indexed to inflation) and a $500,000 investment limit (also indexed).

• Qualifying real property does not share in the expensing benefits allowed under the new law. The October 2010 tax law allowed a taxpayer to elect up to $250,000 of the $500,000 section 179 deduction limit for qualifying real property for any tax year beginning in 2010 or 2011. The new law does not extend this treatment.

Federal Transfer Tax

The pre-2001 estate tax (maximum tax rate of 55 percent and $1 million exclusion amount) was scheduled to be reinstated on Jan. 1, 2011. The new 2011-2012 estate tax regime has delayed this reinstatement until Jan. 1, 2013. Highlights of the new law are as follows:

• For decedents dying in 2010, estates have the option of electing the estate tax based on the new law (making it voluntarily retroactive to Jan. 1, 2010) or opting out and applying the estate-tax free, stepped-up basis regime previously legislated under I.R.C. § 1022.

• For decedents dying in 2011 or 2012, estates of up to
$5 million will be federal-estate-tax free. For estates of more than $5 million, a tax of 35 percent of the portion of the estate above $5 million will be owed.

• For decedents dying after 2012, the pre-2001 estate tax applies ($1 million exclusion; top tax rate of 55 percent).

Exemption Portability. The new law allows a surviving spouse to use the unused exclusion from the deceased spouse’s estate, by election at the first death. The portability is available for decedents dying after Dec. 31, 2010, but it sunsets on Dec. 31, 2012.

Analysis. With careful estate planning, married couples can effectively shield up to $10 million from estate tax by providing that each spouse maximize his or her $5 million exclusion. However, the utility of this law is limited to situations in which both spouses die within the two-year period. Also, this portability provision does not extend to the generation-skipping transfer tax. Portability is a new concept to the tax code and, as a very basic tool, allows the executor or administrator of an estate to make an election on a death tax return allowing for tax treatment of a marital deduction trust being funded, even if no trust exists. It will be interesting to see how the IRS restructures form 706 to deal with this new provision.

Gift Tax Relief. Gifts made in 2010 will be subject to an exclusion amount of $1 million. However, for gifts made after 2010, the gift tax is reunified with the estate tax, with a new exclusion of $5 million, until Dec. 31, 2012.

Individuals

Lower Individual Income Tax Rates. The 2001 law made across-the-board rate reductions and the 2010 Tax Relief Act keeps all of them, albeit only for two years, at an estimated price tag of about $186 billion. The president stated that he will make the sunset of the two highest brackets an issue in the 2012 presidential campaign. Also subject to debate in the next two years is the status of post-2012 health-care funding taxes.

Example. An example of the effect of the 2011 tax cuts is as follows: An individual earning $50,000 in 2011 will see an approximate tax savings of $1,890 from the combination of income tax and payroll tax rate reductions ($890 and $1,000 respectively) over what was scheduled under the 2001 tax law that would have expired at the end of 2010.

Lower Investment Income Tax Rates. Qualified capital gains and dividends currently are taxed at a maximum rate of 15 percent for 2010. The new law extends this treatment through Dec. 31, 2012. Without the tax relief, the rate on qualified dividends also would have increased from 15 percent to equal the tax rates on regular income, which could have reached as high as 39.6 percent.

Planning Tip. Although the extension of the lower capital-gain rates received most of the publicity from the media, continuation of the 0.0 percent rate will be as important to many taxpayers, from students to retirees. To the extent that capital gains and dividends do not exceed the top of the 15 percent income tax bracket ($34,500 for singles; $69,000 for joint filers in 2011), those capital gains and dividends are effectively tax-free, subject to the 0.0 percent rate.

Caution. Beware of installment payments, which are subject to the tax rates for the year of payment, not the year of sale. Even under the new law, watch out for capital gains from installment sales falling into the pre-2001 capital-gain tax treatment after Dec. 31, 2012.

Itemized Deductions. The 2010 Tax Relief Act extends the full repeal of the limitation of itemized deductions for two years, through Dec. 31, 2012.

Marriage Penalty Relief. By increasing the basic standard deduction for a married couple filing a joint return to twice the amount for a single individual, the new law continues the dampening of the so-called marriage penalty. Under the old law’s sunset rules, the 2011 standard deduction for married couples filing jointly was projected to be $9,650. Under the new law, it probably will be $11,600 for 2011.

Tax Credits. From the American opportunity tax credit to the earned income tax credit, expect several dozen extensions and modifications in 2011. These changes are too numerous to specifically identify in this article.

Example. Although both the adoption credit and the exclusion amount are phased out ratably for taxpayers with modified adjusted gross income between $182,520 and $222,250, these phase outs are now indexed for inflation; however, the 2010 Tax Relief Act does not extend the enhancements to the adoption credit and exclusion made by the Patient Protection and Affordable Care Act (PPACA). Therefore, the credit is not refundable for 2011 and 2012 and the additional $1,000 under the PPACA is not available after Dec. 31, 2010.

Example. The 2009 Recovery Act tripled the $500 individual energy credit to $1,500, and provided that previous 10 percent credits and other items would be eligible for the full 30 percent credit up to $1,500. The new law does not renew any of these enhancements for 2011. Also, the so-called 25C credit for individuals remains nonrefundable under the new law.

Education. The $5,250 employee-tuition-reimbursement exclusion has been extended for two years, through Dec. 31, 2012. Numerous other education incentives also have been extended, including the student-loan-interest deduction and Coverdell education savings accounts (ESAs) and many others.

Comment. The amount of qualified tuition and related expenses for the higher-education-tuition deduction must be reduced for certain items. These include any exclusion from gross income for a Coverdell ESA and income from savings bonds used to pay higher-education tuition and fees. Other limits also apply to the HOPE and lifetime-learning credits.

Alternative Minimum Tax (AMT). A so-called patch has been put into place, without which an estimated 21 million additional households would be subject to the AMT. Higher exemption amounts and other targeted relief are both available for 2010.

Payroll Tax Cut. The new law reduces the amount of the employee share of the Social Security tax from 6.2 percent to 4.2 percent for wages earned in calendar year 2011 up to the taxable wage base of $106,800. Self-employed individuals will pay 10.4 percent on self-employment income up to the threshold.

Example. For a person who makes $50,000 a year, the employee’s share of Social Security tax is reduced from 6.2 percent to 4.2 percent for 2011. Instead of paying $3,100 in OASDI tax for 2011, this individual would pay only $2,100, resulting in a $1,000 tax savings. It is hoped that this payroll-tax holiday will inject more than $110 billion into the economy in 2011.