Tax Changes for 2011 Maybe!

Tax Changes for 2011 – Maybe!

Many of these changes could be reversed if Congress acts as many bills in congress address many of these deductions, credits, and tax hikes. Given the economic environment, the President is in an inevitable tough situation as he doesn’t want the deficit to grow any more than it needs to but yet he doesn’t want to raise taxes especially during tough economic times. Pressure from Congress to curb the rapidly growing deficit coupled with cries from the public against increased taxes leave policy makers with little hope for compromise.

If nothing is done, the largest tax hikes in the history of America will take effect. They will hit families and small businesses on January 1, 2011:

First Wave: Expiration of 2001 and 2003 Tax Relief
Changes With Income Tax Rates and Other Taxes – Tax rates refer to the percentage of taxes that need to be paid with regards to income tax rates, estate transfers, and capital gains.

In 2001 and 2003, the GOP Congress enacted several tax cuts for investors, small business owners, and families. These will all expire on January 1, 2011:

Personal income tax rates will rise. The top income tax rate will rise from 35 to 39.6 percent (this is also the rate at which two-thirds of small business profits are taxed). The lowest rate will rise from 10 to 15 percent. All the rates in between will also rise. Itemized deductions and personal exemptions will again phase out, which has the same mathematical effect as higher marginal tax rates. The full list of marginal rate hikes is below:
- The 10% bracket rises to an expanded 15%
- The 25% bracket rises to 28%
- The 28% bracket rises to 31%
- The 33% bracket rises to 36%
- The 35% bracket rises to 39.6%

• President Obama’s proposed budget for 2011 will extend changes to not only income tax rates but income brackets as well. However, tax breaks for single taxpayers with an income of less than $200,000 and married couples earning less than $250,000 will be exempt from any changes (under his plan).

Higher taxes on marriage and family. Our government is expected to go back to discouraging marriage and the family as the well known “Marriage Penalty” will return with narrower tax brackets from the first dollar of income. Also, the standard deduction will not be doubling for married couples from what it is for single filers (those slated to get married this year or next will be discouraged to do so, if only marginally).

Estate Tax To Increase – The Estate Tax, also referred to as the Death Tax, a term that may hold more meaning to many taxpayers, is set to return. Through the Economic Growth and Tax Relief Reconciliation Act in 2001, the estate tax has been phased out over the past 10 years but will unfortunately reach an end this year. This means that unless Congress has a dramatic change of heart, the estate tax will not only return but is set to increase to 55% for estates valued over $1,000,000 dollars (under Obama plan this tax rate is 45%). A person leaving behind two homes and a retirement account could easily pass along a death tax bill to their loved ones.Therefore, 2010 becomes the year to die!

Capital Dividends and Gains Hikes – Those who fall within the upper tax brackets should prepare themselves for a changing rate. After this year, the current 15% long-term capital gains rate will return to 20%. However, those in the upper tax brackets will not bear the weight alone as most brackets will be affected. Under former President Bush, the lower 15% income tax bracket had a 0% capital gains rate but this number is expected to rise to 10% in 2011. For the upcoming year, dividends, excluding mutual fund capital gain distributions, will no longer be taxed at 15% for those in the upper tax brackets but will instead is set to be taxed as ordinary income. (These rates will rise another 3.8 percent in 2013.) While President Obama is proposing that the dividend rate mentioned here simply be increased to 20% no action has been taken. Regardless of the outcome, those in the upper tax brackets will be faced with a higher tax on dividends.

Second Wave: Obamacare
There are over twenty new or higher taxes in Obamacare. Several will first go into effect on January 1, 2011. They include:
The Tanning Tax. This went into effect on July 1st of this year. It imposes a new, 10% excise tax on those individuals who love to brown their skinat a tanning salon.This is a new tax that will primarily impact individuals at the end of this year/start of next year as fall and winter approach.There is no exemption for tanners making less than $250,000 per year.
Brand Name Pharmaceutical Tax – This tax is an annual tax assessment on brand name pharmaceutical companies which amounts to a total of $2.5 billion for 2011. This tax, like all excise taxes, will raise the price of medicine, hurting everyone asour brand name drug costs will go higher.

HSAs, HRAs, and FSAs Cannot Be Used for Over The Counter Medicine or The “Medicine Cabinet Tax”- Americans will no longer be able to use Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs) and Health Reimbursement Accounts (HRAs) to purchase over the counter medicine if it is not insulin.

The HSA Withdrawal Tax Hike. This provision of Obamacare increases the additional tax on non-medical early withdrawals from an HSA from 10 to 20 percent, disadvantaging them relative to IRAs and other tax-advantaged accounts, which remain at 10 percent.
Economic Substance Doctrine.This sounds confusing but basically is a new IRS provision that gives the IRS more power. If the Internal Revenue Service deems perfectly legal tax deductions as not having “economic substance” because the underlying transactions were enacted to avoid taxes, your business could face penalties. Thisempowers the IRS to disallow perfectly-legal tax deductions and maneuvers merely because it judges that the deduction or action lacks “economic substance.” This is obviously an arbitrary empowerment of IRS agents. (Note: this is very interesting, i.e. scary.)
Employer Reporting of Health Insurance Costs on a W-2. This will start for W-2s in the 2011 tax year. While not a tax increase in itself, it makes it very easy for Congress to tax employer-provided healthcare benefits later.
Third Wave: The Alternative Minimum Tax and Small Business Tax Hikes
When Americans prepare to file their tax returns in January of 2011, they’ll be in for a nasty surprise—the AMT won’t be held harmless, and many tax relief provisions will have expired. These major items include:
The AMT will ensnare over 28 million families, up from 4 million last year. According to the left-leaning Tax Policy Center, Congress’ failure to index the AMT will lead to an explosion of AMT taxpaying families—rising from 4 million last year to 28.5 million. These families will have to calculate their tax burdens twice, and pay taxes at the higher level. The AMT was created in 1969 to ensnare a handful of taxpayers.

Small business expensing will be slashed and 50% expensing will disappear.For 2011 there are several business taxes that will be affected. Small businesses can normally expense (rather than slowly-deduct, or “depreciate”) equipment purchases up to $500,000. This will be cut all the way down to $25,000. Larger businesses can expense half of their purchases of equipment. In January of 2011, all of it will have to be “depreciated.”Of course, as with all tax deductions, other limitations apply.

Of course, there are other tax changes that are either sun setting or expiring that have benefitted us the past couple years. We’ve divided these into credits and deductions:

Changes With Income Tax Credits – Generally, a tax credit is a direct reduction in tax liabilities, and is usually put into place in order to encourage a certain behavior. Sometimes tax credits can even result in a refund. This is different from a tax deduction which only lowers your taxable income. Below are a few tax credit changes we will see in 2011:

• Child Tax Credit Reduced – In 2011, the child tax credit will be cut in half to $500 per child and may not even be applicable to all taxpayers. For those filing jointly, the tax credit begins to phase out at $110,000 (AGI) and for taxpayers completing a single tax return at $75,000. While President Obama has mentioned the possibility of increasing this tax credit for families that fall under the middle class, no action has thus far been taken.
• Making Work Pay Tax Credit Gone – This year workers are able to get a tax credit for 6.2% of their earned income with a maximum credit of $400 for single filers and $800 for married couples. In 2011, this tax credit will be eliminated unless Congress acts as Obama’s proposal seeks to extend this credit in 2011.
• Earned Income Tax Credit Reduced for Some – This is a tax credit for low-income working families with earned income less than or equal to $48,362. The income limits on this credit vary by your filing status and by the number of children you claim as dependents. In 2011, the EITC is expected to decrease for families with three or more children with higher income phase outs eliminated.
• Hope Tax Credit Changed – This tax credit goes back to being only applicable for the first 2 years of college and the limit goes from being $2500 to $1800. Of course there are income limits as well with this credit. Obama has stated he wants to make the changes with this tax credit in 2010 permanent but nothing is set in stone yet.
• Energy-Saving Credits Gone – The current 2010 credit for principal residence homes making changes to housing insulation, windows, doors, HVAC equipment, water heaters and more will expire next year. This tax credit allowed up to 30% ($1.5k max limit) back with applicable energy efficiency improvements.
• HomeBuyer Tax Credit for Veterans – If you or your spouse are part of the Armed Forces, Military Intelligence or Foreign Service and have been engaged in activity duty for at least 90 days outside of the United States you have until April 30th, 2011 to sign a real estate contract and close by at least June 30th, 2011.
• Dependent care and adoption tax credits will also be cut unless congress does something, which they probably will.
  

Changes With Tax Deductions – A tax deduction is not a tax credit. Instead, a tax deduction lowers a taxpayer’s gross income or tax base in exchange for a certain behavior or action. Therefore, it normally reduces indirectly by lowering the amount the taxpayer pays.

• Mortgage Insurance Premium Deduction Gone – Beginning January 1, 2011, taxpayers will no longer be allowed to deduct mortgage insurance premiums from their tax returns. Previously, homeowners who were paying insurance premiums for mortgage contracts that were signed after December 31, 2006 were able to take this deduction assuming they fell within the income cap of $100,000 for families.
• Student Loan Interest Deduction Limit Changes – For 2011, individuals or married couples can only deduct interest from the first 60 months of the repayment term. Moreover, the phase out income limits for claiming the deduction for both single filers and married couples will come down.
• Tax Benefits for Education and Teaching Reduced.The deduction for tuition and fees will not be available. Employer-provided educational assistance is curtailed. The student loan interest deduction will be disallowed for hundreds of thousands of families.

Other Notable Tax Changes:

• Coverdell ESA and 529 Plan Alterations – Previously, under a 529 Plan, taxpayers with children were encouraged to invest after-tax money into an account that increased with tax free withdrawals assuming the money was being used to contribute towards education. However, in 2011, 529 Plan withdrawals will not be tax free when paying for the cost of computers or internet access. Coverdell ESA Plan will see changes as well. This plan is similar to the 529 Plan but is directed towards elementary and secondary educational costs. In 2011, the maximum contribution limit per year on this plan will drop dramatically from $2,000 to $500 unless Congress moves quickly.
• Charitable Contributions from IRAs no longer allowed. Under current law, a retired person with an IRA can contribute up to $100,000 per year directly to a charity from their IRA. This contribution also counts toward an annual “required minimum distribution.” This ability will no longer be there.
  

By the time you have see this some of these things will have changed. We’d guess that more than half of them will be changed by the lame duck Congress, if they change anything at all. But for now, this is where we are at.

November 22, 2010