INTRODUCTION
The year of 2010 saw a host of changes in the tax law. The first round of legislation came in March with the enactment of the massive health care bill, formally called the Patient Protection and Affordable Care Act, as amended by the Health Care and Reconciliation Act of 2010 (the Health Care Act). Although this legislation was aimed at health insurance reform, there were a number of provisions that affected the Internal Revenue Code. March also was the stage for the passage of the Hiring Incentives to Restore Employment Act (HIRE Act). This Act included a number of tax incentives for job creation and retention. A few months later, on September 27, 2010, President Obama signed into law theSmall Business Jobs Act of 2010(the Jobs Act). The year closed for tax legislation on December 17, 2010 when President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (hereinafter referred to as the Act or the 2010 Act or Tax Relief Act). All of the legislation impacted the tax law but none more so than the Tax Relief Act. The Act extends for two years (2011 and 2012) the so-called Bush tax cuts contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).
Upon its passage in May, 2001, EGTRRA was hailedby its proponents asthe biggest tax cut in history. It made sweeping changes in the tax law, including cuts in the tax rates, marriage penalty relief and repeal of the estate tax. Importantly, however, EGTRRA contained a sunset provision; that is, all provisions of the Act were set to expire at the close of 2010. In the supplement to the 2002 edition for that year we wrote:
Perhaps the most interesting part of theEconomic Growth and Tax Relief Reconciliation Act of 2001 is the surprise ending. Virtually all of the changes made by the Act are repealed in 2011. The repeal was necessary to satisfy Senate budget rules. Consequently, the entire set of tax breaks just enacted will expire in 2011 and will have to be reinstated by a future Congress.
While most believed that action on the EGTRRA provisions would occur long before the 2011 sunset, Congress waited till the final weeks of 2010 to move. Congress responded with enactment of The Tax Relief Act. For the most part, the Act simply continues the current law—continues EGTRRA—through 2011 and 2012. Thus, in 2013, Congress will get another chance to determine whether the EGTRRA changes should survive.
Perhaps the most important provisions of the Tax Relief Act are those that retain the current tax rates as well as the favorable 15 percent rate for long-term capital gains and qualified dividends. No doubt, the provision that will be felt immediately by working Americans is the temporary cut in social security taxes. All employed and self employed individuals get immediate tax relief from employment taxes with a 2 percentage point cut in the social security tax rate for 2011 (from 6.2% to 4.2% for employees and 12.4% to 10.4% for self-employed persons). In addition, Congress passed a two-year fix for the alternative minimum tax that ensures millions will not be hit by the tax. The Act also contains several new tax breaks. At the top of the list is a provision that generally allows businesses to deduct immediately—rather than depreciate—the cost of new property placed in service after September 8, 2010 and before January 1, 2012. Finally, the Actaddresses the repeal of the estate tax. The new law does not go so far as to repeal the estate and gift tax. However, the revisions ensure that only the wealthiest of individuals—those with net wealth exceeding $5,000,000 ($10,000,000 for married couples) will be subject to the tax. The new law also extends many expired and expiring tax breaks for businesses and individuals.
This supplement focuses primarily on changes made by the Tax Relief Act. Since most provisions of the health legislation do not become effective until later years the discussion is limited to changes on the immediate horizon as well as those that have already been the subject of debate (e.g., imposition of a Medicare tax on those with substantial investment income).
The changes introduced by the new laws are reflected in the following pages and are referenced to the 2011 Edition by chapter and page. In addition, this update includes a discussion of other important developments that have occurred since the book went to press.
SUPPLEMENT TO ACCOMPANY
INDIVIDUAL TAXATION
2011 EDITION
Pratt and Kulsrud
Changes Introduced by the:
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,
Small Business Jobs Act of 2010
Hiring Incentives to Restore Employment Act of 2010
Patient Protection and Affordable Care Act of 2010
Pratt-Kulsrud Tax Series
CengageCorporation
All rights reserved. The contents or parts thereof, may be reproduced for classroom use
with Individual Taxation2011 Edition by Pratt and Kulsrud, provided such reproductions
bear copyright notice and the number reproduced does not exceed the number of students
using the text, but may not be reproduced in any form for any other purpose without
written permission of the publisher
Cengage Corporation
SUPPLEMENT (2011 eDITION) 1
INSIDE FRONT COVER: 2011 Tax Rates (as adjusted for inflation)
2011 Tax Rates Single
If taxable income is % on Of the
OverBut not over The tax is + ExcessAmount over
$ 0$ 8,500 $ 0.00 10% $ 0
8,500 34,500 850.00 15 8,500
34,50083,600 4,750.00 25 34,500
83,600174,400 17,025.00 28 83,600
174,400379,150 42,449.00 33 171,850
379,150 110,016.50 35 379,150
2011 Tax Rates Married Filing Jointly
If taxable income is % on Of the
OverBut not over The tax is + ExcessAmount over
$0$ 17,000 $ 0.00 10% $ 0
17,00069,000 1,700.00 15 17,000
69,000139,350 9,500.00 25 69,000
139,350212,300 27,087.50 28 139,350
212,300373,650 47,513.50 33 212,300
379,150 102,574.00 35 379,150
2011 Head of Household
If taxable income is % onOf the
OverBut not over The tax is + ExcessAmount over
$ 0$ 12,150 $ 0.00 10% $ 0
12,150 46,250 1,215.00 15% 12,150
46,250119,400 6,330.00 25% 46,250
119,400193,350 24,617.50 28% 119,400
193,350379,150 45,323.50 33% 193,350
379,150 106,637.50 35% 379,150
2011 Married, Filing Separate [§1(d)]
If taxable income is % onOf the
OverBut not over The tax is + ExcessAmount over
$0$ 8,500 $ 0.00 10% $ 0
8,50034,500 850.50 15% 8,500
34,50069,675 4,750.00 25% 34,500
69,675106,150 13,543.75 28% 69,675
106,150189,575 23,756.75 33% 106,150
189,575 51,287.00 35% 189,575
Standard Deduction
Amount
Filing Status / 2011 / 2010
Single / $ 5,800 / $ 5,700
Unmarried head of household / 8,500 / 8,400
Married persons filing a joint return (and surviving spouses) / 11,600 / 11,400
Married persons filing a separate return / 5,800 / 5,700
Exemption Amount
2011 / 2010
Personal exemption / $3,700 / $3,650
Dependency exemption / 3,700 / 3,650
Individual who can be claimed as dependent on another’s return / 950 / 950
CHAPTER 1:AN OVERVIEW OF FEDERAL TAXATION
Page 1-5
Federal Wealth Transfer Taxes
Due to an improbablechain of political events, the estate tax was allowed to expire in 2010. In effect, rates fell from 45% in 2009 to zero in 2010—causing some taxpayers to cling to life (or their family members to delay pulling plugs) until 2010 to save money for their heirs. However, before the obituary for the tax could be written,it was quickly resurrected. On its resurrection, the Wall Street Journal noted, “[t]hus would end one of the sorriest episodes in U.S. tax history: the Great Estate-Tax Lapse of 2009” (December 11, 2010).
For those who died in 2010 and who would have been subject to the estate tax, the temporary death of the death tax was no doubt a huge windfall. One possible benefactor was George Steinbrenner, the owner of the New York Yankees baseball franchise, who died in July, 2010. Initial estimates indicated his estate, which primarily consisted of the Yankee baseball team, was worth over $1.4 billion. Had Steinbrenner died in 2009 his estate tax would have been roughly $630,000,000 (45% x $1.4 billion). His timely death produced huge savings. However, while substantial estate taxes were saved by those who died in 2010, there was a drawback of the repeal: the basis of property to the decedent’s heirs generally carried over to the heirs rather than being stepped-up to fair market value.
Although Congress revived the estate tax for 2011 and 2012, it made major changes. Generally, the tax applies only to decedents with net wealth (assets minus liabilities) exceeding $5,000,000 ($10,000,000 for married couples). These changes are discussed in greater detail below.
Page 1-8
Tax Rates
The new law addresses the increase in the tax rates that was scheduled for 2011. Without action, the rates were scheduled to rise to pre-EGTRRA levels: 15%, 28%, 31%, 36% and 39.6%. In addition, the 15% tax bracket for joint filers and qualified surviving spouses was scheduled to drop to 167% of the 15% tax bracket for individual filers. Under the new law, the taxrate schedules for individuals will not increase. They remain at 10%, 15%, 25%, 28%, 33% and 35% for two additional years through 2011 and 2012. In addition, the size of the 15% tax bracket for joint filers and qualified surviving spouses will remain at 200% of the 15% tax bracket for individual filers through 2012. The rates for 2011 as adjusted for inflation are shown below:
Single TaxpayersMarried Taxpayers
Tax RateTaxable IncomeTaxable Income
10% $ 0 – $ 8,500 $ 0 – $ 7,000
15% 8,500 – 34,500 17,000 – 69,000
25% 34,500 – 83,600 69,000 – 139,350
28% 83,600 – 174,400 139,350 – 212,300
33% 174,400 – 379,150 212,300 – 379,150
35% Over 379,150 Over 379,150
The lower income tax rates are set to expire after 2012. See “Inside Front Cover” above for the 2011 tax rates.
President Obama has promised that he willmake the sunset of the two highest brackets anissue in the 2012 presidential campaign. If that were to occur, the top tax rates would move to 36% and 39.6% from 33% and 35%. Another rate issue surely to see debate will be the status of the 2013health care (i.e., Medicare) taxes wherebyhigher-income individuals (i.e., above a$200,000 threshold for single and head-of-householdfilers, and a $250,000 threshold forjoint filers) will be subject to an additional 0.9percent Medicare tax on earnedincome (moving the tax from 1.45 to 2.35 percent) and a3.8 percent Medicare tax on unearnedincome. Note that unearned income is currently not subject to either Medicare or Social Security taxes.
The rate cut will provide real benefits for working America. When the 2 percentage point payroll taxcut (discussed below)is added to the extension of theindividual rate cuts, many individuals will see asignificant increase in take-home incomeavailable to them in 2011 over what would havebeen the case without the Tax Relief Act.
Page 1-14
Wealth Transfer Taxes
The Bush tax cuts,officially contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA),provided for the gradual reduction of the estate tax beginning in 2002 and in its outright repeal in 2010. However, the law was structured in such a way that if Congress did nothing, the estate tax was to be reinstated in 2011 in the same form as before the Bush legislation. As a practical matter, most believed that repeal would never occur and ultimately Congress would reach some type of compromise that would extend the estate tax in some modified form. But, the unthinkable actually occurred and the estate tax was repealed—but only for one year, 2010. The new law resurrects the estate tax but only for 2011 and 2012, leaving everyone to wonder what will happen in 2013. If Congress does not act, in 2013, the exemption (i.e., unified credit equivalent) is scheduled to decrease once again to only $1 million with a top rate of 55 percent.
Although Congress reestablished the estate tax for 2011 and 2012, significant changes were made in both the estate tax and the gift tax. Under the new law, the estate tax as well as the gift has limited reach. The revised estate tax applies only to decedent’s with net wealth (assets minus liabilities) exceeding $5,000,000.
The new law creates a new “portability” rule that allows a surviving spouse to use the unused credit of his or her last spouse. The effect of this operates so that married couples normally will not be taxed unless their estate exceeds $10,000,000.
(Note: technically the estate tax was reinstated for 2010 with a $5,000,000 exemption, a top rate of 35% and a basis for inherited property of fair market value at date of death. Estates for those dying in 2010 that want to avoid paying estate taxes and accept the modified carryover basis rules must elect not to pay the taxes. In other words, estates that do nothing are subject to revived estate tax rules. However, since the vast majority of individuals dying in 2010 will have estates less than the taxable threshold, they will pay no estate taxes and the basis of property passing to their heirs will be their fair market value at date of death.)
Page 1-14
The gift tax exclusion for 2011 remains at $13,000.
For 2010 the taxable threshold at which cumulative taxable gifts are taxed is $1,000,000. The Act increases the threshold temporarily to $5,000,000 for 2011 and 2012. Although the gift tax exemption remains at $1,000,000 for 2010, the top gift tax rate in 2010 is reduced to 35% as is the estate tax rate.
Page 1-15
Under the new law, the top rate for the gift tax and the estate tax for 2010, 2011 and 2012 is 35%. The gift and estate tax rates are shown below
ESTATE AND GIFT TAX RATES 2010
If taxable transfer isOf the
Over But not over Tax liability Amount over
$ 0$10,00018%$ 0
10,00020,000$1,800 + 20%10,000
20,00040,0003,800 + 22%20,000
40,00060,0008,200 + 24%40,000
60,00080,00013,000 + 26%60,000
80,000100,00018,200 + 28%80,000
100,000150,00023,800 + 30%100,000
150,000250,00038,800 + 32%150,000
250,000500,00070,800 + 34%250,000
500,000750,000155,800 + 35%500,000
Unified Credit. The unified credit for the estate tax for 2010 and 2011 is $1,730,800 and offsets the tax on transfers of $5,000,000 as shown below.
Taxable estate $5,000,000
Estate tax
Tax on $500,000 $ 155,800
Tax on remaining $4,500,000 x 35% 1,575,000
$1,730,800
Unified credit for 2010, 2011 and 2012 (1,730,800)
Estate tax due $ 0
The credit is adjusted for inflation for decedent’s dying after 2011 (§2010(c)).
While the unified credit for gift tax is the same as the estate tax credit for 2011 and 2012 ($1,730,800 that shelters $5,000,000 in transfers), it is unchanged for 2010. Thus, the unified credit for the gift tax for 2010 remains at $345,800, sheltering only $1,000,000 in taxable gifts.
The unified credit was initially set at $30,000 in 1977 and increased to $47,000 in 1981, eliminating the tax on a gross estate of $175,625. The credit was substantially increased by the Reagan administration in the Economic Recovery Tax Act of 1981, reaching $192,800 in 1987 where it exempted $600,000 from tax. From 1987 through 1996, the taxable threshold remained at $600,000. However, in the Taxpayer Relief Act of 1997, Congress acted again to increase the credit. Beginning in 1998, the credit began to increase gradually to its current level. The Bush tax-cuts contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), decoupled the credit for estate and gift tax, capping the unified credit for the gift tax so that it would exempt $1,000,000 but allowing the credit for estate to grow to exempt $3,500,000 before the repeal of the estate tax in 2010. The changes in the credit and the equivalent exemption are shown in the table below.
Credit Exemption Equivalent
Year Estate Tax Gift TaxEstate TaxGift Tax
1/1/77- 6/30/77 $ 6,000Same$ 30,000Same
7/1/77-12/31/77 30,000Same120,666Same
1978 34,000 Same 134,000Same
1979 38,000 Same 147,333Same
1980 42,500 Same 161,563Same
1981 47,000 Same 175,625Same
1982 62,800 Same 225,000Same
1983 79,300 Same 275,000Same
1984 96,300 Same 325,000Same
1985 121,800 Same 400,000Same
1986 155,800 Same 500,000Same
1987-97 192,800 Same600,000Same
1998 202,050 Same 625,000Same
1999 211,300 Same 650,000Same
2000-01 220,550 Same675,000Same
2002-03 345,800 Same1,000,000Same
2004-05 555,800 345,8001,500,0001,000,000*
2006-08 780,800 345,8002,000,000 1,000,000
2009 1,455,800 345,8003,500,0001,000,000
2010** 1,730,800 345,8005,000,0001,000,000
2011-12 1,730,800 Same5,000,000Same
* Beginning in 2004, the estate and gift tax exemptions differ. The gift tax exemption was frozen at $1,000,000. However, the 2010 Act reunited the gift tax credit and the estate tax credit so they once again would be the same at $1,730,800, exempting $5,000,000 from tax.
** Estates of individuals dying in 2010 had the option to not pay any estate tax but accept a modified carryover basis. Note that the unified credit for the estate and gift tax differ for 2010 but are once again unified in 2011. Interestingly, top tax rate for both the estate and gift tax beginning in 2010 is 35%.
Portability of the Unused Unified Credit (§ 2010(c)). The 2010 Tax Relief Act introduced the so-called portability rule. According to this rule, any credit/exemption/exclusion that remains unused as of the death of a spouse who dies after 2010 (the “deceased spousal unused exclusion amount”) is portable; that is, the unused amount is generally available for use by the surviving spouse as an addition to the surviving spouse's exemption. Specifically, beginning in 2010 a surviving spouse may use the predeceased spousal carryover amount in addition to his or her own $5 million exclusion for taxable transfers made during life or at death (§ 2010(c)).
Example. H and W are husband and wife. H dies in 2011 and uses $3,000,000 of his $5,000,000 exemption to eliminate his estate. As a result, $2,000,000 of his exemption is unused. In 2012, W dies. W’s exemption amount is $7,000,000 (her $5,000,000 + the unused amount of her last deceased husband of $2,000,000). In effect, the couple is able to exempt up to $10 million from estate taxes ($3,000,000 when H died and $7,000,000 when W died).
If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by such surviving spouse is limited to the lesser of $5 million or the unused exclusion of the last such deceased spouse.
Example. H and W are married. H dies and his unused exclusion is $5,000,000. W remarried NH, a new husband. NH died and his unused exclusion is $2,000,000. By what amount can W increase her exemption? She can use only the unused amount of her last spouse, $2,000,000 (and not the $5,000,000 of her first spouse). Perhaps W should consider this when she remarries.
The unused exclusion amount is available to a surviving spouse only if the executor of the estate of the deceased spouse files an estate tax return on which such amount is computed and makes an election on such return that such amount may be used. The election is irrevocable. The election cannot be made unless that estate tax return is filed on a timely basis as extended. Thus, even if a decedent normally is not required to file an estate tax return, it appears that a return is now necessary simply to preserve the unused exclusion amount.
Page 1-17
Example 16. The result remains the same under the new law. In 2011, the taxpayer could make a taxable gift of up to $5,000,000 and pay no tax.
Unified Credit for Gift Tax. As noted above, the unified credit for the gift tax is not changed for 2010, remaining at $345,800 to exempt $1,000,000 from gifts. However, for 2011 and 2012 it is raised to the equivalent of the credit for the estate tax, $1,730,800 that exempts $5,000,000 of taxable transfers.