Tax Relief Act of 2010

Congress has passed a comprehensive set of income tax, estate tax and unemployement insurance provisions as outlined by the deal previously negotiated between President Obama and Republican legislators. The following explains the Act in five sections:

Individual Income Tax Provisions
Education
Trust, Estate and Decendent Income Tax
Estate, Gift and Generation-Skipping Transfer Taxes
Business Provisions.

Individual Income Tax Provisions

Individual Income Tax Brackets are Extended Through 2012

The 2010 Tax Relief Act provides that individuals’ taxable income for 2011 and 2012 will continue to be subject to six tax brackets, taxed at 10%, 15%, 25%, 31%, 33%, and 35% marginal tax rates.

Congress provided the projected 2011 tax rate schedules reproduced below. They reflect extension of the rate changes above, extension of the expanded 15% rate bracket for married joint filers, and all applicable inflation adjustments.

Projected 2011 Rate Schedules
For Single Individuals (Other than Heads of Households and Surviving Spouses)

If taxable income is:	The tax would be:
Not over $8,500	10% of taxable income
Over $8,500 but not over $34,500	$850.00 plus 15% of the excess over $8,500
Over $34,500 but not over $83,600	$4,750.00 plus 25% of the excess over $34,500
Over $83,600 but not over $174,400	$17,025.00 plus 28% of the excess over $83,600
Over $174,400 but not over $379,150	$42,449.00 plus 33% of the excess over $174,400
Over $379,150	$110,016.50 plus 35% of the excess over $379,150

For Heads of Households

If taxable income is:	The tax would be:
Not over $12,150	10% of taxable income
Over $12,150 but not over $46,250	$1,215.00 plus 15% of the excess over $12,150
Over $46,250 but not over $119,400	$6,330.00 plus 25% of the excess over $46,250
Over $119,400 but not over $193,350	$24,617.50 plus 28% of the excess over $119,400
Over $193,350 but not over $379,150	$45,323.50 plus 33% of the excess over $193,350
Over $379,150	$106,637.50 plus 35% of the excess over $379,150

For Married Individuals Filing Joint Returns and Surviving Spouses

If taxable income is:	The tax would be:
Not over $17,000	10% of taxable income
Over $17,000 but not over $69,000	$1,700.00 plus 15% of the excess over $17,000
Over $69,000 but not over $139,350	$9,500.00 plus 25% of the excess over $69,000
Over $139,350 but not over $212,300	$27,087.50 plus 28% of the excess over $139,350
Over $212,300 but not over $379,150	$47,513.50 plus 33% of the excess over $212,300
Over $379,150	$102,574.00 plus 35% of the excess over $379,150

For Marrieds Filing Separate Returns

If taxable income is:	The tax would b:e
Not over $8,500	10% of taxable income
Over $8,500 but not over $34,500	$850.00 plus 15% of the excess over $8,500
Over $34,500 but not over $69,675	$4,750.00 plus 25% of the excess over $34,500
Over $69,675 but not over $106,150	$13,543.75 plus 28% of the excess over $69,675
Over $106,150 but not over $189,575	$23,756.75 plus 33% of the excess over $106,150
Over $189,575	$51,287.00 plus 35% of the excess over $189,575

Expansion of Marrieds-Filing-Jointly 15% Rate Bracket to Provide Marriage Penalty Relief is Extended Through 2012

A “marriage penalty” exists whenever the tax on a couple’s joint return is more than the combined taxes each spouse would pay if they were not married and if each filed a single or head of household return. The tax is more on a joint return if the couple’s taxable income is pushed into a higher marginal tax bracket than would apply if the couple were not married (so they pay at a higher tax rate on the same total income than they would pay if each were single). And that usually happens where both spouses work and have relatively equal incomes.

Prior law phased-in an increase in the size of the 15% regular income tax rate bracket for a married couple filing a joint return to equal twice the size (200%) of the corresponding rate bracket for an unmarried (single) individual. The Economic Growth and Tax Relief Act of 2001 (EGTRRA) also provided special inflation adjustments rules relating to this change.

The 2010 Tax Relief Act provides that the EGTRRA sunset will not take effect until after December 31, 2012. That is, for 2011 and 2012 the expanded 15% bracket for married joint filers, and the related special inflation adjustment rules, remain in effect.

Because the lowest tax rate bracket (the 10% bracket) for married joint filers for 2011 and 2012 is twice the size of the 10% bracket for single filers, for 2011 and 2012, the tax on a couple’s income reported on a joint return, up to the maximum income level under their 15% bracket, equals the tax two single filers-each reporting half that joint income-would pay.

Because all of the tax brackets for joint filers are not made equal to twice the corresponding single filer tax brackets, however, the marriage penalty effect under the income tax rate schedules is not completely eliminated by the above-described changes.

Kiddie Tax Rates are Extended Through 2012

The 2010 Tax Relief Act provides that the EGTRRA sunset will not take effect until after December 31, 2012 (instead of after December 31, 2010)

That is, as a result of the above extension, for tax years 2011 and 2012:

Kiddie tax – a parent who elected to report a child’s income on the parent’s return must also include 10% (instead of 15%) of the lesser of: (a) the inflation-adjusted standard deduction in effect for the tax year allowable to a child who can be claimed as a dependent on the parent’s return, or (b) the excess of the child’s gross income over that amount.
Backup withholding rate on reportable payments – the rate stays at 28% (instead of rising to 31%).
Minimum withholding rates on supplemental wages under flat rate method – the optional flat rate for payments totaling $1 million or less for a calendar year stays at 25% (instead of rising to 28%), and the mandatory flat rate for payments totaling more than $1 million stays at 35% (instead of rising to 39.6%).
Voluntary withholding rates on specified federal payments – the rates stay at 7%, 10%, 15%, or 25% (instead of rising to 7%, 15%, 28%, or 31%)
Voluntary withholding on unemployment benefits – the rate stays at 10% (instead of rising to 15%).
Withholding on gambling winnings – the rate stays at 25% (instead of rising to 31%).
Withholding on Indian casino profits distributed to tribal members – the rate stays at 31%.

0% and 15% Capital Gain Rates are Extended Through 2012

A noncorporate taxpayer’s adjusted net capital gain is taxed at a maximum rate of 15%, or, to the extent it would have been taxed at a 10% or 15% rate if it had been ordinary income, at a maximum rate of 0%. These rates apply for both regular income tax and alternative minimum tax (AMT).

“Adjusted net capital gain” is net capital gain plus qualified dividend income, minus specified types of long-term capital gain that are taxed at a maximum rate of 28% (gain on the sale of most collectibles and on the unexcluded part of Code Sec. 1202 small business stock) or 25% (unrecaptured section 1250 gain, i.e., gain attributable to real estate depreciation).

“Net capital gain” is the excess of net long-term capital gains over net short-term capital losses for a tax year.

Under section 303 of the 2003 Jobs and Growth Act (JGTRRA), as amended by section 102 of the 2005 Tax Increase Prevention Act:

The 0% and 15% maximum rates on adjusted net capital gain were scheduled to expire for tax years beginning after December 31, 2010.
The rates in effect before passage of JGTRRA, which ranged from 8% to 20%, were scheduled to come back into effect.

The 2010 Tax Relief Act extends the 0% and 15% rates on adjusted net capital gain for two additional years, so that they apply for tax years beginning before January 1, 2013.

This two-year extension dispels some of the uncertainty that surrounded year-end tax planning for capital gains in 2010. Before the sunset was extended, individuals with large gains and few available losses to offset them faced the difficult choice of whether to realize some gains in 2010 to lock in the 15% rate, given the possibility that capital gain rates could rise for 2011. The extension of the sunset eliminates the rate increase as a consideration in year-end planning.

0% and 15% Rates on Qualified Dividend Income of Noncorporate Taxpayers are Extended Through 2012

“Qualified dividend income” – generally, dividends received from domestic corporations and “qualified foreign corporations,” subject to holding period requirements and specified exceptions – is effectively treated as, and is taxed at the same 0% and 15% maximum rates that apply to, adjusted net capital gain.

For dividends on stock to qualify as qualified dividend income, the taxpayer must hold the stock for at least 61 days during the 121-day period beginning 60 days before the ex-dividend date.

The amount of a taxpayer’s “unrecaptured section 1250 gain” – that portion of a noncorporate taxpayer’s long-term capital gain that is attributable to real estate depreciation – that is eligible to be taxed at a maximum 25% rate is limited to the taxpayer’s net capital gain determined without regard to the taxpayer’s qualified dividend income.

Under section 303 of the 2003 Jobs and Growth Act, as amended by section 102 of the 2005 Tax Increase Prevention Act.

The Taxation of qualified dividend income at 0% and 15% rates was scheduled to expire for tax years beginning after December 31, 2010;
Qualified dividend income was then to be taxed at ordinary income rates.

Similarly, the following rules were scheduled to expire for tax years beginning after December 31, 2010:

The holding period rule for determining when dividends on stock qualify as qualified dividend income, and
The exclusion of qualified dividend income from net capital gain for purposes of computing the limitation on the amount of unrecaptured section 1250 gain that is eligible to be taxed at a maximum 25% rate.

The 2010 Tax Relief Act extends the treatment of qualified dividend income as adjusted net capital gain, taxable at the same 0% and 15% maximum rates that otherwise apply to adjusted net capital gain, for two additional years, so that it applies for tax years beginning before January 1 2013.

The 2010 Tax Relief Act also extends the following rules so that they apply for tax years beginning before January 1, 2013:

The holding period rule for determining when dividends on stock qualify as qualified dividend income.
The exclusion of qualified dividend income from net capital gain for purposes of computing the limitation on the amount of unrecaptured section 1250 gain that is eligible to be taxed at a maximum 25% rate.

100% Gain Exclusion for Qualified Small Business Stock (QSBS) is Extended Through December 31, 2011

Subject to a per taxpayer limit, noncorporate taxpayers exclude 100% of the gain realized on the sale of “qualified small business stock” held for more than five years and acquired in a temporary period. Additionally, the excluded portion of the gain from eligible QSBS is excepted from treatment as an alternative minimum tax (AMT) preference item.

The effect of the AMT exception is that, subject to the per taxpayer limit and the more-than-five-year holding requirement, no gain from QSBS acquired during the temporary period is taxed for either regular tax or AMT purposes.

Under pre-2010 Tax Relief Act law, the temporary period began on September 28, 2010 and ended on December 31, 2010.

For periods before and after the temporary period, the exclusion , instead of being a 100% exclusion, is a partial exclusion, allowed in varying amounts. Thus, for stock acquired before or after the temporary period, the excluded percentage is 50% (60% for certain stock issued by corporations in empowerment zones), but is 75% for any QSBS acquired after February 17, 2009 and before September 28, 2010.

For regular income tax purposes, the portion of the gain that is includible in taxable income is taxed at a maximum rate of 28%. Thus, for regular tax purposes, the gain from QSBS that is subject to the 50% exclusion is taxed at a maximum effective rate of 14%, and the gain from QSBS that is subject to the 75% exclusion is taxed at a maximum effective rate of 7%.

Also, for periods before and after the temporary period discussed above, a varying percentage of the excluded portion of gain from QSBS is treated as a preference item and, thus, is included in income. The percentage is equal to 7%, 28% or 42%, depending on when the stock was acquired and other facts.

Generally, QSBS must be acquired by the taxpayer at original issue and after August 10, 1993. Also, QSBS must be issued by a corporation that meets a gross assets limit and certain other requirements. Under the per taxpayer limit, the gain excludible by a taxpayer for the QSBS of any one corporation is the greater of:

ten times the taxpayer’s basis (excluding post-issuance basis increases) in that corporation’s QSBS disposed of by the taxpayer in the tax year, or
$10 million ($5 million if married filing separately), and the $10 million (or $5 million) amount is reduced by the total amount of eligible gain taken into account by the taxpayer on dispositions of that corporation’s QSBS in earlier tax years.

The 2010 Tax Relief Act extends the 100% exclusion and exception from minimum tax treatment for QSBS for one year by changing the date before which eligible QSBS must be acquired from January 1, 2011 to January 1, 2012.

Thus, subject to the per taxpayer limit (see above) and the more-than-five-year holding requirement (see above), no regular tax or AMT is imposed on the sale or exchange of QSBS acquired after September 27, 2010 and before January 1, 2012.

On October 1, 2011, T, and individual, acquires at original issuance 100 shares of QSBS at a total cost of $100,000. T sells all of the shares on October 2, 2016 for $1.1 million. Assuming that none of the possible income exclusion is barred by the per taxpayer limit (see above), T excludes from income all of the $1 million of gain for regular tax and AMT purposes.

Unless Congress extends beyond December 31, 2011 the deadline for acquiring QSBS eligible for the 100% gain exclusion, the 50% and 60% gain exclusion rules will again be in effect, and a percentage of the excluded portion of the gain will be treated as a preference item for AMT purposes.

15% Accumulated Earnings Tax Rate and 15% Personal Holding Company Tax Rate are Extended Through 2012

The 2003 Jobs and Growth Act (JGTRRA) reduced the maximum tax rate paid by noncorporate taxpayers on qualified corporate dividends to 15%. Because the purpose of the accumulated earnings tax and the personal holding company tax was to prevent corporations from accumulating their earnings and not distributing the earnings as taxable dividends, the 2003 Jobs and Growth Act also reduced the accumulated earnings tax rate and the undistributed personal holding company tax rate of 15%.

Under §303 of the 2003 Jobs and Growth Act as amended by §102 of the 2005 Tax Increase Prevention and Reconciliation Act, the rules that subject qualified dividend income to a maximum 15% tax rate and the rules reducing the accumulated earnings tax rate and the undistributed personal holding company tax rate to 15% were due to expire at the end of 2010.

The 2010 Tax Relief Act extends the 15% maximum tax rate that applies to qualified dividend income for two additional years. In connection with that extension, the 2010 Tax Relief Act also extends the 15% accumulated earnings tax rate and the 15% undistributed personal holding company tax rate for two additional years, so that they apply for tax years beginning before January 1, 2013.

Exclusion of Qualified Dividend Income from Investment Income is Extended Through 2012

A noncorporate taxpayer’s deduction for investment interest expense is limited to the amount of the taxpayer’s net investment income, i.e., the excess of investment income over investment expenses for the year. Any investment interest that is disallowed because it exceeds this limit is carried over to the next tax year and treated as investment interest paid or accrued in that year.

Qualified dividend income (dividends taxed at the 0% or 15% capital gain rates) is included in “investment income” for this purpose only to the extent the taxpayer so elects. Any amount that the taxpayer elects to treat as investment income is not treated as qualified dividend income and is not eligible to be taxed at the 0% or 15% rates.

This means that a taxpayer whose investment interest deduction is limited because the interest exceeds the amount of his net investment income can increase the deduction by electing to include all or part of qualified dividend income in investment income. The cost of making the election is that the dividends will be taxed as ordinary income rather than capital gain.

The 2010 Tax Relief Act extends the above rule regarding the treatment of qualified dividend income as investment income so that it applies for tax years beginning before January 1, 2013.

Employee’s Social Security Tax Rate for 2011 is Reduced from 6.2% to 4.2%

FICA Tax
The Federal Insurance Contributions Act (FICA) imposes two taxes on employers and employees, an old-age, survivors, and disability insurance (OASDI) tax, commonly referred to as social security tax, and a hospital insurance (HI) or Medicare tax.

For 2011, the OASDI tax is computed on the first $106,800 of the employee’s wages. The HI tax is computed on the employee’s total wages.

The HI tax rate is 1.45%. Under pre-2010 Tax Relief Act law, the OASDI tax was 6.2%, for a combined tax rate of 7.65% on both employers and employees.

Making Work Pay Credit
For tax years beginning in 2009 and 2010, eligible individuals were allowed a refundable income tax credit (the “making work pay credit”) equal to the lesser of:

6.2% of the taxpayer’s earned income, or
$400 ($800 for a joint return). The credit was phased out at a rate of 2% of the taxpayer’s modified adjusted gross income (MAGI) above $75,000 ($150,000 for joint returns).

Payroll Tax Holiday for Workers Hired in 2010
The employer OASDI tax was forgiven for wages paid from March 19, 2010 to December 31, 2010 to workers hired after February 3, 2010, who certified that they had not been employed for more than 40 hours during the 60-day period ending on the date they started employment.

The 2010 Tax Relief Act reduces the employee OASDI tax rate from 6.2% to 4.2% for 2011. The employer OASDI tax rate remains at 6.2% A similar rate reduction applies to the railroad retirement tax.

Under the 2010 Tax Relief Act, the employee OASDI tax rate is 4.2% for remuneration received during the “payroll tax holiday period,” defined as calendar year 2011.

The FICA tax rate for 2011 on employees’ wages up to $106,800 is 5.65% (4.2% OASDI tax +1.45% HI tax). On wages in excess of $106,800, the rate is 1.45%.

The maximum reduction in FICA tax for an individual employee is $2,136 ($106,800 x .02). For a married couple, each with wages of $106,800 or more, the maximum reduction would be $4,272.

The OASDI tax rate reduction differs from the payroll tax holiday that was in effect for 2010. The holiday was designed to encourage hiring of unemployed workers by forgiving the employer’s OASDI tax for those workers. The rate reduction cuts the employee’s OASDI tax for all employees, not just the newly-hired. It is designed to boost consumer spending by giving workers a de facto pay increase, in the hope that the increased demand will lead to new hiring.

Transfers to Trust Funds
The Federal Old-Age and Survivors Trust Fund and the Federal Disability Insurance Trust Fund will receive transfers from the General Fund of the U.S. Treasury equal to the reduction in revenues attributable to the OASDI rate reduction. The transfers will be made at the times and in the manner that replicate to the extent possible the transfers that would have occurred without the rate reduction. (2010 Tax Relief Act §601(e)(1))

Similar transfers will be made to the Social Security Equivalent Benefit Account established under the Railroad Retirement Act of 1974 (45 USC 231n-1(a)). (2010 Tax Relief Act §601(e)(2))

Self-Employed Individual’s Social Security Tax Rate for 2011 is Reduced from 12.4% to 10.4%

The Self-Employment Contributions Act (SECA) imposes two taxes on self-employed individuals: an old-age, survivors, and disability insurance (OASDI) tax, commonly referred to as social security tax, and a hospital insurance (HI) or Medicare tax.

These SECA taxes apply to “net earnings from self-employment” above a $400 minimum for the tax year. There is an annually-adjusted ceiling limitation on the amount subject to OASDI tax ($106,800 for 2011), but no limit on the HI tax.

The HI tax rate is 2.9%. Under pre-2010 Tax Relief law, the OASDI tax rate was 12.4%.

Income Tax Deduction
An income tax deduction is allowed for a portion of SECA tax. The deduction is taken above the line, in computing adjusted gross income (AGI). Under pre-2010 Tax Relief law, this deduction was allowed for one-half of SECA tax.

SECA Tax Deduction for Half of SECA Taxes
Taxpayers are allowed a SECA tax deduction under Code Sec. 1402(a)(12) in computing net earnings from self-employment equal to:

That taxpayer’s net earnings from self-employment, as determined before taking the Code Sec. 1402(a)(12) deduction into account, multiplied by
One –half of the sum of the OASDI tax rate and the HI tax rate.

This deduction is built into the SECA tax calculation on Schedule SE (Form 1040). It is taken when the taxpayer’s trade or business income is multiplied by .9235 on Schedule SE.

The 2010 Tax Relief Act reduces the OASDI tax rate under the SECA tax from 12.4% to 10.4% for tax years of self-employed individuals that begin in 2011. This parallels the two-percentage-point reduction in the OASDI portion of an employee’s FICA tax, from 6.2% to 4.2%

Temporary SECA Tax Reduction
The tax rate for the OASDI portion of SECA tax is 10.4% for tax years that begin in the “payroll tax holiday period”, defined as calendar year 2011.

For 2011, the SECA tax rate for 2011 on net earnings from self-employment up to $106,800 is 13.3% (10.4% OASDI tax + 2.9% HI tax). On net earnings from self-employment in excess of $106,800, the rate is 2.9%.

The maximum reduction in SECA tax for a self-employed individual is $2,136 ($106,800 x .02). For a married couple, each with net earnings from self-employment of $106,800 or more, the maximum reduction would be $4,272.

Income Tax Deduction Percentage is Increased
The income tax deduction allowed under Code Sec. 164(f) for tax years beginning in 2011 is computed at the rate of:

59.6% of the OASDI tax paid, plus
50% of the HI tax paid.

The 59.6% of the OASDI tax paid replaces the 50% rate allowed under pre-2010 Tax Relief Act law. The increased percentage is necessary to allow the self-employed taxpayer to deduct the full amount of the employer portion of SECA taxes.

The total OASDI tax rate of 2011 is 10.4% (6.2% employer portion + 4.2% employee portion). Thus, the employer share of total OASDI taxes is 59.6% (6.2 ÷ 10.4) of the OASDI portion of SECA taxes.

SECA Tax Deduction Is Unchanged
The rate reduction is not taken into account for purposes of the Code Sec. 1402(a)(12) SECA tax deduction allowed for determining the amount of the net earnings from self-employment for the tax year.

Thus, the deduction for 2011 remains at 7.65% of self-employment income (determined without regard to the Code Sec. 1402 (a)(12) deduction).

AMT Relief in The 2010 Tax Relief Act

Brief Overview of the AMT
The AMT is a parallel tax system which does not permit several of the deductions permissible under the regular tax system, such as property tax. Taxpayers who may be subject to the AMT must calculate their tax liability under the regular federal tax system and under the AMT system taking into account certain “preferences” and “adjustments”. If their liability is found to be greater under the AMT system, that’s what they owe the federal government. Originally enacted to make sure that wealthy Americans did not escape paying taxes, the AMT has started to apply to more middle-income taxpayers, due in part to the fact that the AMT parameters are not indexed for inflation.

In recent years, Congress has provided a measure of relief from the AMT by raising the AMT “exemption amounts” – allowances that reduce the amount of alternative minimum taxable income (AMTI), reducing or eliminating AMT liability. (However, these exemption amounts are phased out for taxpayers whose AMTI exceeds specified amounts.) For 2009, the AMT exemption amounts were $70,950 for married couples filing jointly and surviving spouses; $46,700 for single taxpayers; and $35,475 for married filing separately. However, for 2010, those amounts were scheduled to fall back to the amounts that applied in 2000: $45,000, $33,750, and $22,500, respectively. This would have brought millions of additional middle-income Americans under the AMT system, resulting in higher federal tax bills for many of them, along with higher compliance costs associated with filling out and filing the complicated AMT tax form.

New Law Provides Two-Year Stopgap Fix
To prevent the unintended result of having millions of middle-income taxpayers fall prey to the AMT, Congress has once again relied on a temporary “patch” to the problem, this time a two-year extension of the 2009 exemption amounts, increased slightly. Under the new law, for tax years beginning in 2010, the AMT exemption amounts are increased to:

$72,450 in the case of married individuals filing a joint return and surviving spouses;
$47,450 in the case of unmarried individuals other than surviving spouses; and
$36,225 in the case of married individuals filing a separate return.

For tax years beginning in 2011, the AMT exemption amounts are increased to:

$74,450 in the case of married individuals filing a joint return and surviving spouses;
$48,450 in the case of unmarried individuals other than surviving spouses; and
$37,225 in the case of married individuals filing a separate return.

Personal Credits May Be Used to Offset AMT Through 2011
Another provision in the new law provides AMT relief for taxpayers claiming personal tax credits. The tax liability limitation rules generally provide that certain nonrefundable personal credits (including the dependent care credit and the elderly and disabled credit) are allowed only to the extent that a taxpayer has regular income tax liability in excess of the tentative minimum tax, which has the effect of disallowing these credits against the AMT. Temporary provisions had been enacted which permitted these credits to offset the entire regular and AMT liability through the end of 2009. The new law extends this temporary provision to 2010 and 2011.

2010/2011 AMT Exemption Amounts are Retroactively Increased to $47,450/$48,450 for Unmarrieds and $72,450/$74,450 for Joint Filers

In computing the alternative minimum tax (AMT) for individuals, the AMT tax rate is applied against the taxpayer’s alternative minimum taxable income (AMTI), as reduced by the taxpayer’s exemption amount (which phases out for AMTI above certain threshold levels).

Pre-2010 Tax Relief Act law provided the following statutory AMT exemption amounts for tax years beginning in 2010 (and later years):

$33,750 for unmarried individuals who are not surviving spouses;
$45,000 for married couples filing jointly and surviving spouses; and
$22,500 (technically, 50% of the joint return/surviving spouse amount) for married individuals filing separately.

AMT “patch” provisions (to reduce the number of individuals who otherwise would be subject to the AMT) began with the temporary increases to the AMT exemption amounts provided by the Economic Growth and Tax Relief Reconciliation Act of 2001. Additional increases for 2003 and 2004, and temporary increases for 2005, were provided by the Jobs and Growth Tax Relief Reconciliation Act of 2003 and the Working Families Tax Relief Act of 2004, respectively.

Later legislation also provided similar one-year “patches” for 2006 through 2009. For example, the 2009 Recovery Act provided the following higher AMT exemption amounts for tax years beginning in 2009:

$46,700 for unmarried individuals who were not surviving spouses;
$70,950 for married couples filing jointly and surviving spouses; and
$35,475 for married individuals filing separately.

Under pre-2010 Tax Relief Act law, the temporary increases expired after 2009. This meant that the lower generally applicable statutory AMT exemption amounts were to apply for 2010 and 2011.

The 2010 Tax Relief Act increases the individual AMT exemption amounts for 2010 and 2011 (rather than allowing them to decrease to pre-“patch” statutory levels). Specifically, for tax years beginning in 2010, the AMT exemption amounts are:

$72,450 (up from $70,950 in 2009) for married couples filing a joint return and surviving spouses;
$47,450 (up from $46,700 in 2009) for an individual who is not married or a surviving spouse; and
$36,225 (up from $35,475 in 2009) for married individuals filing separate returns.

For tax years beginning in 2011, the AMT exemption amounts will be further increased as follows:

To $74,450 for married couples filing a joint return and surviving spouses;
To $48,450 for an individual who is not married or surviving spouse; and
To $37,225 for married individuals filing separate returns.

AMT Exemption Amount for Estate and Trusts
The 2010 Tax Relief Act does not change the $22,500 exemption amount for an estate or trust.

Phase-Out of AMT Exemption Amount
The 2010 Tax Relief Act does not change the phase-out rules for the AMT exemption amount. Under those rules, the AMT exemption amount is reduced by an amount equal to 25% of the amount by which the individual’s AMTI exceeds the following threshold amounts:

$112,500 for unmarried individuals,
$150,000 for married individuals filing a joint return and surviving spouses, and
$75,000 for married individuals filing separate returns.

0% and 15% AMT Capital Gain Rates are Extended Through 2012

The 2010 Tax Relief Act extends the 0% and 15% AMT rates on adjusted net capital gain for two additional years, so that they apply for tax years beginning before January 1, 2013.

Nonrefundable Personal Credits Can Offset AMT Through 2011 (Instead of 2009)

Individuals can qualify for a number of nonrefundable personal tax credits. These credits are subject to limitations based on tax liability. For tax years when Code Sec. 26(a)(2) applies, the credits can be used to offset alternative minimum tax (AMT) as well as regular income tax. For tax years when Code Sec. 26(a)(2) does not apply, most of the credits are subject to Code Sec. 26(a)(1), which does not allow the AMT offset. Certain “specified personal credits” are excepted from Code Sec. 26(a)(1) and have their own separate limitations that allow the AMT offset.

For tax years beginning before 2010 (tax years when Code Sec. 26(a)(2) applied), the nonrefundable personal credits were allowed to the extent of the full amount of the individual’s regular tax and AMT.

The 2010 Tax Relief Act (“the Act”) extends Code Sec. 26(a)(2) so that it applies to tax years beginning during 2010 and 2011. This allows an individual to offset the entire regular tax liability and AMT liability by the nonrefundable personal credits for 2010 and 2011.

$1,000 Per Child Amount and Expanded Refundability of Child Tax Credit are Extended Through 2012

An individual may claim a child tax credit (CTC) for each qualifying child under the age of 17.

Sec. 201 of the 2001 Economic Growth and Tax Relief Reconciliation Act as amended by the 2003 Jobs and Growth Tax Relief Reconciliation Act and the 2004 Working Families Tax Relief Act, modified the CTC as follows:

The per child amount of the CTC was gradually increased to $1,000 (from $500).
The CTC was made refundable for all taxpayers with qualifying children, regardless of the number of children, to the extent of 15% of the taxpayer’s earned income in excess of a threshold amount (the “earned income formula”). This statutory threshold amount of $10,000 was indexed for inflation from 2001. Families with three or more children were allowed to compute their refundable CTC using the earned income formula or by using the method available to them under pre-EGTRRA law (the excess, if any, of the taxpayer’s social security taxes over the EIC for the year).

The 2010 Tax Relief Act (the Act) extends the EGTRRA changes to the CTC for two years (through 2012) by postponing the EGTRRA sunset date to December 31, 2012. Specifically, the Act provides that the provisions of, and amendments made by, EGTRRA will not apply to tax years beginning after December 31, 2012 (instead of after December 31, 2010). In other words, the $1,000 per child amount of the CTC and the earned income formula for determining the refundable portion of the credit are extended for two years (through 2012).

EGTRRA-Expanded Dependent Care Credit is Extended Through 2012

Taxpayers who have one or more qualifying individuals (a dependent qualifying child under age 13, or a dependent or spouse who is incapable of self-care and has the same principal place of abode as the taxpayer for more than half the tax year) are allowed a dependent care credit equal to a percentage of the expenses paid for the care of the qualifying individual(s) that enable the taxpayer to be gainfully employed (“eligible expenses”).

Sunset
The EGTRRA enhancements to the dependent care credit are subject to the EGTRRA sunset provision. After the EGTRRA sunset date, the credit percentage, credit base, and maximum credit all revert to the lower pre-EGTRRA levels after. That is, the credit percentage drops to 30% and begins to phase out at AGI of $10,000. The maximum credit drops to $720 (30% of up to $2,400 of eligible expenses) for one qualifying individual, and to $1,440 (30% of up to $4,800 of eligible expenses) for two or more.

Under pre-2010 Tax Relief Act law, the EGTRRA enhancements to the dependent care credit were scheduled to sunset after December 31, 2010. This meant that the above-described reductions to the credit percentage, credit base, and maximum credit were to apply for tax years beginning after December 31, 2010. That is, the reduced amounts were to be in effect for 2011 and later years.

The 2010 Tax Relief Act (the Act) extends the dependent care credit EGTRRA expansion for two years (through 2012) by postponing the EGTRRA sunset date to December 31, 2012 (instead of December 31, 2010). Specifically, the Act provides that the provisions of, and amendments made by, EGTRRA will not apply to tax years beginning after December 31, 2012 (instead of after December 31, 2010).

In other words, the expanded dependent care credit rules provided under EGTRRA §204 apply for an additional two years. That is, for 2011 and 2012, qualifying taxpayers with AGI of $15,000 or less are allowed a dependent care credit equal to 35% of eligible expenses paid during the year. The percentage decreases by 1% for each $2,000 (or fraction thereof) of additional AGI, until it is reduced to 20% (at AGI of $43,000). The maximum amount of expenses that can be used to compute the credit is $3,000 for one qualifying individual and $6,000 for two or more qualifying individuals. Thus, the maximum credit is $1,050 (35% x $3,000) for one qualifying individual, and $2,100 (35% x $6,000) for two or more.

EIC Simplification is Extended Through 2012

Certain low- and moderate-income workers are allowed a refundable credit, the “earned income credit” (EIC). Eligibility for the EIC is based, in part, on earned income, adjusted gross income, filing status, and number of qualifying children. The amount of the EIC is based on the presence and number of qualifying children in the taxpayer’s family, as well as on adjusted gross income (AGI) and earned income. The EIC is computed (subject to a phaseout) by multiplying a credit percentage by the taxpayer’s earned income.

The EIC generally equals a specified percentage of earned income up to a maximum dollar amount. The maximum amount applies over a certain income range and then diminishes to zero over a specified phaseout range. For taxpayers with earned income (or AGI, if greater) in excess of the beginning of the phaseout range, the maximum EIC amount is reduced by the phaseout rate multiplied by the amount of earned income (or AGI, if greater) in excess of the beginning of the phaseout range. For taxpayers with earned income (or AGI, if greater) in excess of the end of the phaseout range, no credit is allowed.

The 2010 Tax Relief Act provides that the EGTRRA sunset will not take effect until after December 31, 2012 (instead of after December 31, 2010). The EGTRRA changes to the EIC rules described above are extended for two years (through 2012). As discussed above, these include: (1) a simplified definition of earned income; (2) a simplified relationship test; (3) use of AGI instead of MAGI; (4) a simplified tie-breaking rule; and (5) the repeal of the prior-law provision that reduced an individual’s EIC by the amount of his AMT liability.

Expanded Adoption Credit Rules (But Not Refundability) are Extended Through 2012

Under Code Sec. 36C, individuals are allowed a credit for qualified adoption expenses paid or incurred for the adoption of an eligible child (the “adoption credit”). The credit is refundable, and is allowed against income tax and alternative minimum tax (AMT). The maximum credit is $13,170 per eligible child for 2010 ($13,360 for 2011), for both special needs and non-special needs adoptions. The credit begins to phase out for taxpayers with modified adjusted gross income (AGI) over $182,520 for 2010 ($185,210 for 2011) and is fully eliminated at modified AGI of $222,520 for 2010 ($225,210 for 2011). All these dollar amounts are adjusted annually for inflation.

The 2010 Tax Relief Act (the Act) extends the EGTRRA expansion of the adoption credit rules for one year (through 2012) by postponing the general EGTRRA sunset date to December 31, 2012 and removing the EGTRRA changes from the changes subject to the special sunset date.

The December 31, 2011 sunset date for the 2010 Patient Protection and Affordable Health Care Act (PPACA) changes means that the changes will not apply for tax years beginning after December 31, 2011. The adoption credit rules will revert to pre-PPACA law. This means that in 2012:

The maximum per-child credit will drop to $12,170 (indexed for inflation after 2010);
The credit will not be refundable, and will not be provided by Code Sec. 36C. Instead, it will be a nonrefundable credit provided by Code Sec. 23;
The credit will be subject to the tax liability limitations (under either Code Sec. 26(a)(2) or Code Sec. 23(b)(4), whichever applies), and carryover rules that applied before the PPACA changes were enacted; and
The references to Code Sec. 23 that were deleted from certain credit provisions will be restored.

The December 31, 2012 sunset date for the EGTRRA changes means that the changes will not apply for tax years beginning after December 31, 2012. The adoption credit rules will revert to pre-EGTRRA law. This means that starting in 2013:

The credit will be available only for special need adoptions;
The maximum per-child credit will drop to $6,000, and will depend on actual expenses;
The modified AGI starting point for the credit phase-out will be reduced to $75,000 – i.e., the credit will be eliminated at modified AGI of $115,000;
Absent a further extension of Code Sec. 26(a)(2), the credit will not be allowed against AMT because it will be subject to the general Code Sec. 26(a)(1) tax liability limitation.

Nonbusiness Energy Property Credit is Extended for 2011 under Pre-2009 Recovery Act Rules

Individuals are allowed a nonrefundable personal income tax credit, known as the nonbusiness energy property credit, for certain energy efficient property installed in a dwelling located in the U.S. and owned and used by the taxpayer as the taxpayer’s principal residence.

Under pre-2010 Tax Relief Act law, the credit was equal to 30% of the sum of:

The amount paid or incurred by the taxpayer during the tax year for qualified energy efficiency improvements (building envelop components meeting certain requirements) installed during the tax year, and
The amount of residential energy property expenditures paid or incurred by the taxpayer during the tax year for the purchase of (a) advance main air circulating fans, (b) qualified natural gas, propane, or oil furnace or hot water boilers, and (c) energy-efficient building property.

The aggregate amount of the credit allowed for a taxpayer for tax years beginning in 2009 and 2010 is $1,500. The credit was not available for property placed in service in 2008, but a credit of 10% of qualified energy efficiency improvements plus specified dollar amounts for residential energy property expenditures, subject to a $500 lifetime limit ($200 for windows), applied for 2006 and 2007.

Under pre-2010 Tax Relief Act law, the credit was not available for property placed in service after December 31, 2010.

The 2010 Tax Relief Act:

Extends the credits for one year;
Returns to the credit structure and rates in effect before the 2009 Recovery Act;
Allows the credit for windows, skylights, and doors that meet the Energy Star standards;
Restores to their previous levels certain efficiency standards that were weakened by the 2009 Recovery Act;
Reinstates the rule that denies the credit for expenditures made from subsidized energy financing.

Credit Extended for One Year
Under the 2010 Tax Relief Act, the nonbusiness energy property credit will not apply for property placed in service after December 31, 2011 (rather than after December 31, 2010).

Credit Rates and Limits Return to Pre-2009 Recovery Act Rules
Under the 2010 Tax Relief Act, the nonbusiness energy property credit is equal to the sum of:

10% of the amount paid or incurred by the taxpayer for qualified energy efficiency improvements installed during the tax year, and
The amount of the residential energy property expenditures paid or incurred by the taxpayer during the tax year.

Thus, the credit consists of a 10% credit for the purchase of energy-efficient building envelope components that meet certain requirements and specified credits for the purchase of specific energy efficient property placed in service by the taxpayer during the tax year.

Dollar Limits on Residential Energy Property Expenditures
The credit allowed for residential energy property expenditures cannot exceed:

$50 for each advanced main air circulating fan;
$150 for each qualified natural gas, propane, or oil furnace or hot water boiler; and
$300 for each item of energy-efficient building property.

Lifetime Limit is $500 ($200 for Windows)
Under the 2010 Tax Relief Act, a taxpayer’s maximum nonbusiness energy property credit for all tax years is $500, no more than $200 of which may be for expenditures on windows.

Thus, the nonbusiness energy property credit allowed to a taxpayer for a tax year cannot exceed the excess (if any) of $500 over the aggregate nonbusiness energy property credits allowed to that taxpayer for all earlier tax years ending after December 31, 2005.

The nonbusiness energy property credit allowed for amounts paid or incurred for exterior windows and skylights by a taxpayer for any tax year cannot exceed the excess (if any) of $200 over the aggregate nonbusiness energy property credits allowed for those amounts for all earlier tax years ending after December 31, 2005.

The above credit rates, dollar limits, and lifetime limits are the same as in effect for 2006 and 2007. The 2009 Recovery Act provided an enhanced nonbusiness energy property credit for 2009 and 2010, but the 2010 Tax Relief Act returns the credit to its earlier, less generous form for 2011.

To apply the $500 lifetime limit, the taxpayer must look back to all tax years for which the nonbusiness energy property credit was in effect. Those years include 2006 and 2007, when the credit was subject to a $500 lifetime limit, and 2009 and2010, when there was a $1,500 aggregate limit.

If the total of nonbusiness energy property credits for all earlier years is $500 or more, the taxpayer cannot claim a credit for 2011. If the total is less than $500, the taxpayer can claim up to $500 minus the total credits claimed in earlier years.

Personal Exemption Phaseout (PEP) Will Not Apply Until After 2012 (Instead of After 2010)

Taxpayers are allowed two types of personal exemptions: the exemption for the taxpayer and the taxpayer’s spouse, also referred to as the “personal exemptions” and the exemption for dependents. An individual is entitled to a deduction of a $3,650 for 2010 (as adjusted for inflation) for a personal exemption.

Under the personal exemption phaseout (PEP) rules in effect before the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA), the exemption amount of a taxpayer whose adjusted gross income (AGI) for the tax year exceeded a specified threshold amount was reduced by an applicable percentage. The applicable percentage was two percentage points for every $2,500 (or fraction of $2,500) by which the taxpayer’s AGI for the tax year exceeded the threshold amount. The threshold amount varied, depending on the taxpayer’s filing status.

EGTRRA Changes

Reduced the PEP for tax years beginning after December 31, 2005, and before January 1, 2010; and
Eliminated the PEP for tax years beginning after December 31, 2009.

Under pre-2010 Tax Relief Act law, a sunset provision had provided that all changes made by EGTRRA would not apply to tax years beginning after December 31, 2010. In other words, the PEP rules would have reverted to pre-EGTRRA law for tax years beginning after 2010.

Reversion to pre-EGTRRA law would have meant that the PEP would have been in full effect after 2010.

The 2010 Tax Relief Act (Act) extends the sunset in Sec. 901 of EGTRRA from “tax years beginning after December 31, 2010” to “tax years beginning after December 31, 2012.”

So, under the Act, the PEP does not apply for two additional years (through 2012).

In other words, by extending the EGTRRA sunset provision as it applies to the EGTRRA changes in the PEP rules, the Act extends for two years the elimination of the PEP rules that otherwise would have expired after 2010. This means that there will be no PEP until after 2012.

Standard Deduction Marriage Penalty Relief is Extended Through 2012

Individuals who do not elect to itemize their deductions are allowed, instead, to deduct from their adjusted gross income (AGI) an inflation-adjusted basic standard deduction to determine their taxable income. The basic standard deduction in 2010 is $5,700 for unmarrieds, $11,400 for marrieds filing jointly and surviving spouses, $5,700 for marrieds filing separately, and $8,400 for heads of household.

Under the standard deduction rules in effect before the 2001 Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the basic standard deduction for married taxpayers filing jointly and qualified surviving spouses was the statutory amount of $5,000, as adjusted annually for inflation; for single taxpayers who were not surviving spouses or heads of household, it was the statutory amount of $3,000, as adjusted annually for inflation; for marrieds filing separately, it was the statutory amount of $2,500, as adjusted annually for inflation. So, the basic standard deduction amount for joint filers and surviving spouses under the pre-EGTRRA rules was 167% (1.6667 x $3,000 = $5,000) of the basic standard deduction amount for single taxpayers who were not surviving spouses or heads of household. And the standard deduction for marrieds filing separately was half the joint filer amount.

A “marriage penalty” exists when the combined tax liability of a married couple filing a joint return is greater than the sum of the tax liabilities of each individual computed as if they were not married.

EGTRRA, as amended by the Jobs Growth and Tax Relief Reconciliation Act of 2003, and the Working Families Tax Relief Act of 2004, increased the basic standard deduction for joint filers and surviving spouses to 200% of the dollar amount in effect for an unmarried individual or a married taxpayer filing a separate return for the tax year.

The EGTRRA increase in the basic standard deduction amount for joint filers was intended to mitigate the so-called “marriage penalty.”

EGTRRA also made the basic standard deduction for marrieds filing separately equal to the basic standard deduction for single filers.

The 2010 Tax Relief Act (Act) extends the sunset in Sec. 901 of EGTRRA from “tax years beginning after December 31, 2010” to “tax years beginning after December 31, 2012.” So, under the Act, the basic standard deduction for a married couple filing a joint return is increased to twice the basic standard deduction for an unmarried individual filing a single return, for two years (through 2012). And, for two years (through 2012), the basic standard deduction for marrieds filing separately is made equal to the basic standard deduction for single filers.

In other words, by extending the EGTRRA sunset provision as it applies to the EGTRRA/JGTRRA/WFTRA changes to the standard deduction rules, the Act extends for two years the standard deduction marriage penalty relief that otherwise would have expired at the end of 2010. The basic standard deduction for a married couple filing a joint return continues to be twice the basic standard deduction for an unmarried individual filing a single return. And the basic standard deduction for marrieds filing separately equals the basic standard deduction for single filers.

Overall Limitation on Itemized Deductions Will Not Apply Until After 2012 (Instead of After 2010)

Under an overall limitation on itemized deductions in effect before the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA), if an individual’s adjusted gross income (AGI) exceeded the “applicable amount,” the amount of the itemized deductions otherwise allowed for the tax year was reduced by the lesser of : (i) 3% of the excess of AGI over the applicable amount, or (ii) 80% of the amount of itemized deductions otherwise allowable for the tax year.

The above-described reduction in total itemized deductions is referred to as the “overall limitation on itemized deductions,” the “3%/80% rule,” or the “Pease limitation.”

EGTRRA Changes

Reduced the above reduction in itemized deductions for tax years beginning after December 31, 2005, and before January 1, 2010; and
Eliminated the above reduction for tax years beginning after December 31, 2009.

Sunset
Under pre-2010 Tax Relief Act law, a sunset provision in Sec. 901 of EGTRRA had provided that all changes made by EGTRRA would not apply to tax years beginning after December 31, 2010. In other words, the rules for the overall limitation on itemized deductions would have reverted to pre-EGTRRA law for tax years beginning after 2010.

New Law
The 2010 Tax Relief Act (Act) extends the sunset in Sec. 901 of EGTRRA from “tax years beginning after December 31, 2010” to “tax years beginning after December 31, 2012.” So under the Act, the overall limitation on itemized deductions does not apply for two additional years (through 2012).

In other words, by extending the EGTRRA sunset provision as it applies to the EGTRRA changes in the overall limitation on itemized deductions, the Act extends for two years the elimination of the overall limitation on itemized deductions that otherwise would have expired after 2010. This means that there will be no overall limitation on itemized deductions until after 2012.

Election to Claim Itemized Deduction for State/Local Sales Taxes is Retroactively Extended Through 2011

Sec. 501 of the 2004 Jobs Act as amended by Sec. 103 of the 2006 Tax Relief and Health Care Act and Sec. 201(a)DivC of the 2008 Extenders Act provided taxpayers with an election to take an itemized deduction for state and local general sales taxes instead of an itemized deduction for state and local income taxes. Under pre-2010 Tax Relief Act law, this election was available for only tax years beginning after December 31, 2003 and before January 1, 2010.

The 2010 Tax Relief Act (the Act) replaces “January 1, 2010” with “January 1, 2012.” In other words, the Act extends for two years (through December 31, 2011) the provision allowing taxpayers to elect to deduct state and local sales taxes in lieu of state and local income taxes.

Interest Deduction for Mortgage Insurance Premiums is Extended to Amounts Paid or Accrued Before 2012

Premiums a taxpayer paid or accrued during the tax year for qualified mortgage insurance in connection with acquisition indebtedness for the taxpayer’s qualified residence are treated as qualified residence interest, and so are deductible, subject to phaseout rules affecting taxpayers with adjusted gross income (AGI) over $100,000 for the tax year.

“Qualified mortgage insurance” means:

Mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration (FHA), or the Rural Housing Service, and
Private mortgage insurance.

To be deductible qualified residence interest, the amounts must be paid or accrued under a mortgage insurance contract issued after December 31, 2006.

Under the 2010 Tax Relief Act (the “Act”), the rules treating the deduction of qualified mortgage insurance premiums as deductible qualified residence interest do not apply with respect to amounts paid or accrued after December 31, 2011, or properly allocable to any period after that date. So, the Act extends the deduction for private mortgage insurance premiums for one year (only for contracts entered into after December 31, 2006). The Act provides that the deduction applies to amounts paid or accrued in 2011, which are not properly allocable to any period after 2011.

That is, the Act extends the itemized deduction for private mortgage insurance to amounts paid or accrued before January 1, 2012 that are not allocable to any period after December 31, 2011.

Up-to-$250 Above-The-Line Deduction for Teachers’ Out-of-Pocket Classroom-Related Expenses is Retroactively Extended Through 2011

“Eligible educators” – kindergarten through 12^th grade teachers, instructors, counselors, principals, or aides in any elementary or secondary school – are allowed an above-the-line deduction of up to $250 for out-of-pocket expenses they paid in connection with books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services), other equipment, and supplementary materials used in the classroom. Under pre-2010 Tax Relief Act law, this deduction for eligible educator expenses was available in tax years beginning during 2002, 2003, 2004, 2005, 2006, 2007, 2008, or 2009.

The 2010 Tax Relief Act (Act) replaces “or 2009” with “2009, 2010, or 2011.” In other words, the Act extends the deduction for eligible educator expenses for two years so that it is available for tax years beginning before January 1, 2012.

Without the deduction for eligible educator expenses, any unreimbursed expenses that elementary or secondary school teachers might be able to deduct in connection with their teaching activities would be deductible only as unreimbursed employee business expenses – i.e., as miscellaneous itemized deductions subject to the 2%-of-adjusted gross income (AGI) floor on miscellaneous itemized deductions.

Rule Allowing Tax-Free IRA Distributions of Up to $100,000 if Donated to Charity, is Retroactively Extended Through 2011

The Pension Protection Act of 2006 amended the IRA distribution rules to allow tax-free treatment of distributions from IRAs where the distributions are donated to charity. Specifically, a taxpayer may exclude from gross income so much of the aggregate amount of his “qualified charitable distributions” not exceeding $100,000 in a tax year.

A “qualified charitable distribution” is any otherwise taxable distribution from a traditional IRA or a Roth IRA that is:

Made directly by the IRA trustee to a Code Sec. 170(b)(1)(A) charitable organization (other than a Code Sec. 509(a)(3) private foundation or a Code Sec. 4966(d)(2) donor advised fund); and
Made on or after the date on which the individual for whose benefit the IRA is maintained (i.e., the IRA owner) has attained age 70½.

For purposes of the required minimum distribution (RMD) rules as they apply to individual retirement account and individual retirement annuities, qualified charitable distributions may be taken into account to the same extent that the distribution would have been taken into account under the RMD rules had the distribution not been directly distributed under the IRA qualified charitable distribution rules. Thus, an IRA owner who makes an IRA qualified charitable distribution in an amount equal to his RMD for the tax year is considered to have satisfied his minimum distribution requirement for that year, even though a charitable entity (and not the IRA owner) is the recipient of the distribution.

Under pre-2010 Tax Relief Act law, the tax-free qualified charitable distribution rules, above, only applied to distributions made in tax years beginning in 2006 through 2009.

The 2010 Tax Relief Act extends the exclusion for qualified charitable distributions to distributions made in tax years beginning after December 31, 2009 and before January 1, 2012.

Thus, under the Act, taxpayers age 70½ or older may exclude from gross income up to $100,000 of their qualified charitable distributions for each tax year beginning in 2010 and 2011 (in addition to any qualified charitable distributions they may have made in 2006 through 2009).

Special Election for January 2011 Distributions
Under a special rule, for purposes of both (i) the tax-free qualified charitable distribution rules, and (ii) the RMD rules as they apply to individual retirement accounts and individual retirement annuities, any qualified charitable distribution made after December 31, 2010, and before February 1, 2011, will be deemed to have been made on December 31, 2010, if the IRA owner so elects at such time and in such manner as IRS will prescribe.

Thus, a qualified charitable distribution made in January 2011 is permitted to be (a) treated as made in the taxpayer’s 2010 tax year, and thus permitted to count against the 2010 $100,000 limitation on the exclusion, and (b) treated as made in the 2010 calendar year, and thus permitted to be used to satisfy the taxpayer’s RMD for 2010.

John is an individual who is over age 70½, and the owner of a traditional IRA. During 2010, he does not take any distributions from the IRA, even though he is required to take a $100,000 minimum distribution for 2010. On January 18, 2011, John makes a $100,000 charitable transfer.

Under the special rule, John can elect to treat the $100,000 charitable transfer as having been made on December 31, 2010. If John makes the election (pursuant to rules that IRS is to prescribe), he will be (i) considered to have satisfied his minimum distribution requirement for 2010, and (ii) entitled to make another tax-free charitable transfer of up to $100,000 in 2011.

Education

American Opportunity Tax Credit (AOTC) for Higher Education Expenses is extended Through 2012

For tax years beginning before 2009, individual taxpayers could claim a nonrefundable personal credit – the Hope credit (a component credit of the “higher education credit,” along with the Lifetime Learning Credit) – against income tax of up to $1,800 (for 2008) per eligible student for qualified tuition and related (QT&R, see below) expenses paid for the first two years of the student’s post-secondary education in a degree or certificate program. To claim the Hope credit, the student could not have completed the first two years of that post-secondary education before the beginning of the tax year for which the credit was claimed (i.e., the credit was allowed only for QT&R expenses paid for the first two years of the post-secondary education).

Generally, QT&R expenses for the pre-2009 Hope credit included, with specific exceptions, tuition and fees (excluding nonacademic fees) required for the enrollment or attendance of the taxpayer, his spouse, or tax dependent, at a post-secondary educational institution eligible to participate in the federal student loan program.

For 2009 and 2010
For tax years beginning in 2009 and 2010, the American Recovery and Reinvestment Act of 2009 added Code Sec. 25A(i), which increased and expanded the Hope credit and renamed that modified credit the “American Opportunity tax credit” (AOTC). Specifically, the 2009 Recovery Act:

Increased the maximum credit amount to $2,500 per eligible student per year for qualified QT&R expenses. The AOTC equals the sum of (a) 100% of so much of the QT&R expenses paid by the taxpayer during the tax year (for education furnished to the eligible student during any academic period beginning in the tax year) as does not exceed $2,000, plus (b) 25% of the QT&R expenses so paid as exceeds $2,000 but does not exceed $4,000;
Expanded the definition of QT&R expenses to include course materials;
Allowed the AOTC for the first four years of the student’s post-secondary education in a degree or certificate program, if the student has not completed the first four years of post-secondary education before the beginning of the fourth tax year. And, for each eligible student, the AOTC can be claimed for four tax years;
Increased the MAGI range at which the credit is phased-out to between $80,000 and $90,000 ($160,000 and $180,000 for married joint filers);
Applied a separate tax liability limitation permitting the AOTC credit to be claimed against alternative minimum tax (AMT) liability; and
Allowed 40% of the otherwise allowable AOTC to be refundable (unless the taxpayer claiming the credit was a child to whom the Code Sec. 1(g) “kiddie tax” rules apply for the tax year, i.e., generally, any child under age 18 or any child under age 24 who is a student providing less than one-half of his support, who has at least one living parent, and does not file a joint return).

The 2010 Tax Relief Act modifies Code Sec. 25A(i) to provide that they also apply for tax years beginning in 2011 and 2012. That is, the 2010 Tax Relief Act extends for two years (through 2012) the above-described 2009 and 2010 modifications to the Hope credit that are known as the AOTC, including the rules governing treatment of the U.S. possessions.

Specifically, as a result of the above extension of the AOTC, for tax years beginning in 2011 and 2012 (for most individuals who are calendar year taxpayers, 2011 and 2012):

the maximum AOTC credit amount is $2,500 per eligible student per year (computed as described above) for qualified QT&R expenses;
QT&R expenses include tuition, fees, and course materials;
The AOTC is allowed for each of the first four years of the student’s post-secondary education in a degree or certificate program. And, for each eligible student, the AOTC can be claimed for four tax years;
The AOTC is phased-out at MAGI between $80,000 and $90,000 (between $160,000 and $180,000 for joint filers);
The AOTC can be claimed against AMT liability;
40% of the otherwise allowable AOTC is refundable (unless the taxpayer claiming the credit is a child under age 18 or a child under age 24 who is a student providing less than one-half of his support, who has at least one living parent, and does not file a joint return); and
Bona fide residents of U.S. possessions cannot claim the refundable portion of the AOTC credit in the U.S. Instead, they claim the refundable portion in the possession in which they reside (subject to the limitations described above).

Neither the 2009 Recovery Act nor the 2010 Tax Relief Act modify the rules applicable to the Lifetime Learning credit, which, a taxpayer can claim in addition to a Hope credit (collectively, as a higher education credit) for a particular tax year. Thus, existing requirements for eligibility for the Lifetime Learning credit continue to control a taxpayer’s eligibility to claim that credit for 2011 and 2012.

The up-to-$2,000 per year Lifetime Learning credit is calculated on a per family (i.e., per tax return) basis – in contrast to the AOTC which is calculated on a per student basis. However, expenses paid with respect to a student for whom an AOTC is claimed are not eligible for the Lifetime Learning credit – i.e., both credits cannot be claimed for the same student in the same tax year.

Increased $2,000 Contribution Limit and Other EGTRRA Enhancements to Coverdell ESAs are Extended Through 2012

An individual can make a nondeductible cash contribution to a Coverdell education savings account (formerly called an “education IRA”) for qualified education expenses of a beneficiary under the age of 18. A specified aggregate amount can be contributed each year by all contributors for one beneficiary. The amount an individual contributor can contribute is phased out as the contributor’s modified adjusted gross income (MAGI) exceeds specified levels. A 6% excise tax applies to excess contributions.

Earnings on the contributions made to a CESA are subject to tax when withdrawn. But distributions from a CESA are excludible from the distributee’s (i.e., the student’s) gross income to the extent the distributions do not exceed the qualified education expenses incurred by the beneficiary during the tax year the distributions are made. The earnings portion of a CESA distribution not used to pay qualified education expense is includible in a distributee’s income, and that amount is subject to a 10% tax that applies in addition to the regular tax.

Tax-free (including free of the 10% tax described above) transfers or rollovers of CESA account balances from a CESA benefiting one beneficiary to a CESA benefitting another beneficiary (and redesignations of named beneficiaries) are permitted if the new beneficiary is a family member of the previous beneficiary and is under age 30. Generally, a balance remaining in a CESA is deemed to be distributed within 30 days after the beneficiary turns 30.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001, with a technical correction under the Working Families Tax Relief Act of 2004, the CESA rules were modified to:

increase the limit on CESA aggregate annual contributions (from $500) to $2,000 per beneficiary;
permit corporations and other entities (in addition to individuals) to make contributions to a CESA, regardless of the corporation’s or entity’s income;
increase the MAGI phaseout range for joint filers (from $150,000-$160,000) to $190,000-$220,000 to equal twice the range for single filers (i.e., $95,000-$110,000), and so eliminate any “marriage penalty;”
permit contributions to a CESA for a tax year to be made until April 15^th of the following year;
modify the definition of excess contribution to a CESA for purposes of the 6% excise tax on excess contributions to reflect various other EGTRRA changes;
extend the time (to before June 1^st of the following tax year) for taxpayers to withdraw excess contributions (and the earnings on them) to avoid imposition of the 6% excise tax;
expand the definition of education expenses that can be paid by CESAs to include elementary and secondary school expenses (in addition to qualified higher education expenses);
provide for coordination of the Hope and Lifetime Learning credits with the CESA rules to permit a Hope or Lifetime Learning credit to be taken in the same year as a tax-free distribution is taken from a CESA for a designated beneficiary (but for different expenses);
provide rules coordinating distributions from both a qualified tuition program (QTP, or “529 plan”) and a CESA for the same beneficiary for the same tax year (but for different expenses;)
eliminate the age limitations described above for acceptance of CESA contributions, deemed balance distributions, tax-free rollovers to other family-member-beneficiaries, and tax-free change of beneficiaries, for “special needs beneficiaries”;
provide that the 10% additional tax on taxable distributions from a CESA does not apply to distributions of contributions to a CESA made by June 1^st of the tax year following the tax year in which the contribution was made.

Under Sec. 901 of EGTRRA all of the EGTRRA/WFTRA changes described above were scheduled to expire for tax years beginning after December 31, 2010, and the CESA rules in effect before the passage of EGTRRA were scheduled to come back into effect.

The 2010 Tax Relief Act provides that the EGTRRA sunset will not take effect until after December 31, 2012 (instead of after December 31, 2010) i.e., the provision delays the EGTRRA sunset as it applies to CESAs for two years, and the education tax benefits described above continue to be available through 2012.

Specifically, as a result of the above extension, for tax years beginning in 2011 and 2012 (for most individuals who are calendar year taxpayers, 2011 and 2012):

the limit on CESA aggregate annual contributions is $2,000 per beneficiary (and is not decreased to $500 per beneficiary);
corporations and other entities (not just individuals) can make contributions to a CESA, and the corporations and other entities can do so regardless of their income;
the MAGI phaseout range for joint filers is $190,000 – $220,000 (and does not decrease to $150,000 – $160,000);
CESA contributions for a tax year can be made until April 15^th of the following year;
the definition of CESA excess contribution reflects the various other EGTRRA changes to the CESA rules;
taxpayers have until June 1^st of the following tax year to withdraw excess contributions (and the earnings on them) to avoid imposition of the 6% excise tax;
education expenses that can be paid by CESAs include elementary and secondary school expenses and qualified higher education expenses (rather than only qualified higher education expenses);
a Hope or Lifetime Learning credit can be taken in the same year as a tax-free distribution is taken from a CESA for a designated beneficiary (but for different expenses);
the rule coordinating distributions being made from both a QTP and a CESA for the same beneficiary for the same tax year (but for different expenses) applies;
special needs beneficiaries are exempted from the age limitations for a CESA’s acceptance of contributions, deemed balance distributions, tax-free rollovers to other family-member-beneficiaries, and tax-free change of beneficiaries; and
the 10% additional tax on taxable distributions from a CESA is inapplicable to distributions of contributions to a CESA made by June 1st of the tax year following the tax year in which the contribution was made.

Qualified Tuition Deduction is Retroactively Extended Through 2011

An individual is allowed an above-the-line deduction for “qualified tuition and related (QT&R) expenses” for higher education paid by the individual during the tax year. These expenses include tuition and fees for the enrollment or attendance of the taxpayer, the taxpayer’s spouse, or any dependent for whom the taxpayer can claim a personal exemption, at an eligible institution of higher education for courses of instruction at the institution. These expenses must be in connection with enrollment at an institution of higher education during the tax year, or with an academic term beginning during the tax year or during the first three months of the next tax year. The amount of these expenses must be reduced by tax-free educational assistance and certain exclusions from income under the rules for savings bond interest, Coverdell education savings accounts (ESAs), and qualified tuition programs (QTPs or 529 plans).

The maximum deduction is:

$4,000 for an individual whose adjusted gross income (AGI), with certain modifications, does not exceed $65,000 ($130,000 for a joint return),
$2,000 for an individual whose modified AGI exceeds $65,000 ($130,000 for a joint return), but does not exceed $80,000 ($160,000 for a joint return), or
zero for other taxpayers.

Under pre-2010 Tax Relief Act law, the higher-education expense deduction was not available for tax years beginning after December 31, 2009.

The 2010 Tax Relief Act (Act) replaces “ December 31, 2009” with “December 31, 2011.” Thus, the Act extends the qualified tuition deduction for two years so that it is generally available for tax years beginning before January 1, 2012.

Most individuals are on a calendar year. For these individuals, the qualified tuition expenses must be paid before 2012. But, as noted above, the deduction is for expenses in connection with enrollment at an institution of higher education during the tax year, or with an academic term beginning during the tax year or during the first three months of the next tax year. Thus, expenses for an academic term beginning as late as March 31, 2012 may qualify for the deduction, if the taxpayer pays these expenses before 2012.

A taxpayer who plans to go to college or graduate school for an academic term beginning January, February, or March 2012 (or whose spouse or dependent plans to do so) should consider paying some tuition for that term at the end of 2011-namely, the dollar amount equal to the maximum allowable deduction ($4,000 or $2,000, depending on the taxpayer’s modified AGI).

EGTRRA Changes to Student Loan Deduction Rules are Extended Through December 31, 2012

Individuals can deduct a maximum of $2,500 annually for interest paid on qualified higher education loans. The deduction is claimed as an adjustment to gross income to arrive at adjusted gross income (AGI). For 2010, the deduction phases out ratably for taxpayers with modified AGI between $60,000 and $75,000 ($120,000 and $150,000 for joint returns). The phaseout amounts and ranges are indexed for inflation.

The 2010 Tax Relief Act amends 2001 EGTRRA §901 to provide that amendments to the student loan interest deduction rules provided in 2001 EGTRRA §412 do not apply to tax years beginning after December 31, 2012. In other words, the 2010 Tax Relief Act delays the 2001 EGTRRA sunset as it applies to the student loan interest deduction, and this tax benefit will continue to be available through December 31, 2012.

Thus, for tax years beginning after 2010 and before 2013, the 60-month limitation on the student loan interest deduction will not apply. Also, for tax years beginning after 2010 and before 2013, the AGI phaseout ranges will not revert to the AGI phaseout ranges that applied before 2001 EGTRRA. But, absent further legislation, for tax years beginning after 2012, the student loan interest deduction rules will revert to the rules with respect to the 60-month limit on the deduction, the phaseout ranges, and the inflation adjustments to the phaseout ranges that applied before 2001 EGTRRA.

Exclusion for Employer-Provided Educational Assistance, and Restoration of the Exclusion for Graduate-Level Courses, Extended Through 2012

Under Code Sec. 127, an employee’s gross income does not include amounts paid or expenses incurred (up to $5,250 annually) by the employer in providing educational assistance to employees under an educational assistance program. An educational assistance program is a separate written plan of the employer for the exclusive benefit of its employees, having the purpose of providing the employees with educational assistance. The courses taken need not be related to the employee’s job for the exclusion to apply. To be qualified, the program must not discriminate in favor of highly compensated employees, nor may more than 5% of the amounts paid or incurred by the employer for educational assistance during the year be provided for individuals (and their spouses and dependents) owning more than 5% of the employer. Further, the program cannot provide employees with a choice between educational assistance and other remuneration that would be includible in their gross income. Finally, reasonable notification of the program’s availability and terms must be provided to employees.

Under the 2010 Tax Relief Act, the EGTRRA sunset is extended from December 31, 2010 to December 31, 2012. Thus, the Code Sec. 127 exclusion, including the assistance for graduate courses, is available through 2012.

Trust, Estate and Decedent Income Tax

Top Four Reduced Trusts and Estates Income Tax Rates (25%, 28%, 33%, and 35%) are Extended Through 2012

The income tax liability of trusts and estates is computed using a tax rate schedule applicable only for trusts and estates. That tax rate schedule is divided into five income ranges (tax brackets), which are taxed at progressively higher marginal tax rates as the income brackets increase. Each year IRS adjusts each bracket (income range) for inflation (computed from 1992), and IRS’s inflation-adjusted rate schedule is the one used to compute tax (not the statutory rate schedule).

The 2010 Tax Relief Act provides that the EGTRRA sunset will not take effect until after December 31, 2012 (instead of after December 31, 2010). That is, the reduced 25%, 28%, 33%, and 35% rates for taxing trusts’ and estates’ taxable income are extended for an additional two years, through 2012.

That is, trusts’ and estates’ 2011 and 2012 taxable income will continue to be taxed at 15%, 25%, 28%, 33%, and 35% marginal tax rates.

The projected 2011 trusts and estates income tax rate schedule below (reflecting extension of the reduced rates, and applicable inflation adjustments)

Projected 2011 Rate Schedule for Trusts and Estates

If taxable income is:	The tax would be:
Not over $2,300	15% of taxable income
Over $2,300 but not over $5,450	$345.00 plus 25% of the excess over $2,300
Over $5,450 but not over $8,300	$1,132.50 plus 28% of the excess over $5,450
Over $8,300 but not over $11,350	$1,930.50 plus 33% of the excess over $8,300
Over $11,350	$2,937.00 plus 35% of the excess over $11,350

Inclusion of Qualified Dividend Income in Prohibition on IRD Double Benefit is Extended Through 2012

Under Code Sec. 691(c)(4), when “income in respect of a decedent” (IRD) includes net capital gain, including qualified dividend income, to prevent the estate of heirs from receiving the double benefit of both lower capital gains rates on the IRD and the ordinary income deduction allowed for estate tax attributable to that IRD, the amount subject to the lower capital gains rates is reduced by the amount of the IRD deduction.

Under section 303 of the 2003 Jobs and Growth Act, as amended by section 102 of the 2005 Tax Increase Prevention Act, the inclusion of qualified dividend income in this rule was scheduled to expire for tax years beginning after December 31, 2010.

The 2010 Tax Relief Act extends the inclusion of qualified dividend income in the Code Sec. 691(c)(4) prohibition on an IRD double benefit so that it applies for tax years beginning before January 1, 2013.

Passthrough of Qualified Dividend Income by Common Trust Funds is Extended Through 2012

A Code Sec. 584 common trust fund maintained by a bank is not subjected to tax. Instead, each trust participant includes in income its proportionate share of the common trust fund’s short term capital gain or loss, long-term capital gain or loss, and ordinary income, regardless of whether the trust distributes these amounts.

Under the 2003 Jobs and Growth Act, qualified dividend income received by noncorporate shareholders is taxed as a capital gain at a maximum 15% rate. As a conforming change, the 2003 Jobs and Growth Act also provided that each common trust fund participant’s proportionate share of the amount treated as qualified dividends received by the fund is treated as qualified dividend income.

Under the 2010 Tax Relief Act, the 2003 Jobs and Growth Act sunset is extended from December 31, 2010 to December 31, 2012. Thus, the existing rules applicable to qualified dividends, including the passthrough of qualified dividends from a common trust fund, are extended for two additional years.

Estate, Gift, and Generation Skipping Transfer Taxes

Estate and Gift Tax – Overview

The estates of wealthy individuals who died in 2010 did not pay any federal estate tax, but that situation is about to change. Under the recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,” the federal estate tax, which disappeared for 2010, springs back to life in 2011 and is imposed at the top rate of 35% of the estate’s value after the first $5 million.

Background
The modern estate tax dates back to 1916, when it was imposed at a rate of 10% on the portion of estates above $50,000. Over the following years, the rates and exemption amounts have varied, reaching a high of 77% from 1941 to 1976 with a $60,000 exemption amount.

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the first of the two large legislative packages that contain most of what are now commonly referred to as the “Bush tax cuts.” EGTRRA gradually lowered the maximum estate tax rate and substantially raised the applicable exclusion amount over the years 2002 through 2009. The maximum tax rate fell from 60% under the prior law in 2001 (a 55% marginal rate on taxable estate values over $3 million plus a 5% surtax from $10 million to $17 million) to 45% in 2007-2009. EGTRRA repealed the estate tax completely for decedents dying in 2010. That led to several well-publicized instances in which famous people died in 2010 leaving multibillion-dollar estates that will pass to their heirs without paying so much as a penny in federal estate tax. However, all of those provisions were scheduled to sunset on December 31, 2010, meaning that if Congress had not acted, starting January 1, 2011, the estate tax would have sprung back at a level that no one seemed to want. Where the exclusion was $3.5 million ($7 million for couples) in 2009 – a level at which it affected relatively few households – it would have been $1 million ($2 million for couples) in 2011. The tax rate would also have risen, from a top rate of 45% in 2009, to a top rate of 55% in 2011.

New Law
The new law brings back the estate tax, for 2011 and 2012 anyway. During 2011 and 2012, the top rate will be 35%. For 2011, the exemption amount will be $5 million per individual (indexed for inflation after 2011). At those levels, the vast majority of estates (all but an estimated 3,500 nationwide in 2011) will not be subjected to any federal estate tax, and the tax will raise about $11.4 billion for the government. By way of comparison, the 55% tax with a $1 million exemption would have resulted in about 43,540 taxable estates in 2011, and raised about $34.4 billion. Tax historians would also note that except for the temporary repeal of the estate tax in 2010, the estate tax rate has not been less than 45% since 1931.

The new law also gives heirs of decedents dying in 2010 a choice of which estate-tax rules to apply – 2010’s or 2011’s. That is important because although there is no estate tax in 2010, some inherited assets are subject to higher capital gains tax under the 2010 rules, a situation that actually raises the tax burden for some heirs. Inherited assets under the 2010 rules have a tax basis equal to the price when they were purchased (referred to in tax parlance as “carryover basis”) rather than the price at death. That could lead to a significant tax burden for heirs who sell assets such as stocks that had been held for many years and have greatly appreciated in value. Under the 2011 rules, by contrast, heirs will be allowed to inherit assets with a “stepped-up basis.” While most heirs would choose the 2011 regime ($5 million exemption from both estate and generation-skipping tax and an unlimited step-up in the basis of assets to their current market value), the heirs of superrich decedents could find it more advantageous to elect the 2010 law (limited step-up in the basis of assets and no estate tax). If the executor makes the election to have the 2010 rules apply, the estate tax return’s due date will not be earlier that the date that is nine months after the new law’s enactment date.

For gifts made after December 31, 2010, the gift tax will be reunified with the estate tax. Under the new law, the estate and gift tax exemptions will be reunified starting in 2011, which means what the $5 million estate tax exemption will also be available for gifts. The law in effect prior to 2010 provided a $3.5 million lifetime exemption for estates, but only $1 million for gifts. The gift tax rate, starting in 2011, will be 35%. The exemption from the generation-skipping tax (GST) – the additional tax on gifts and bequests to grandchildren when their parents are still alive – will also rise to $5 million from the $1 million it would have been without the new law. The GST tax rate for transfers made in 2011 and 2012 will be 35%.

From a planning standpoint, a nice feature of the new law is that it makes it easier to transfer the $5 million exemption to a surviving spouse, so married couples can shield $10 million of their assets from taxes. In the language of tax professionals, the estate tax exemption will be “portable.”

2010 Modified Carryover-Basis-at-Death Rules and Related Provisions are Repealed

Generally, for decedents dying before January 1, 2010, the basis of most property transferred by reason of the death of an individual had a basis, in the hands of the transferee, equal to the fair market value of that property on the date of death (or six months afterwards if the estate’s alternate valuation date was elected), i.e., the fair market value basis rules, also known as the step-up or step-down basis rules.

However, 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA) repealed the fair market value basis rules for decedents dying in calendar year 2010, and EGTRRA replaced the fair market value basis rules with modified carryover basis rules, under which property acquired from a decedent was treated generally as property acquired by gift, with the basis of the property being the lesser of the property’s adjusted basis or fair market value on the date of death. EGTRRA also allowed an allocation of $1,300,000 ($60,000 for nonresident alien decedents) of basis increases among any properties that were owned (or treated as owned) by the decedent. For decedents other than nonresident aliens, the $1,300,000 was increased by unrealized losses and unused capital loss and net operating loss carryovers. An additional allocation of $3,000,000 of basis increases was allowed for properties deemed to be passing to a surviving spouse. The $1,300,000, $60,000 and $3,000,000 allocations were not permitted for certain types of property or in an amount that would cause the basis of any asset to exceed its date-of-death fair market value.

The termination of the fair market value basis rules and the application of the modified carryover basis rules, and related rules, were to be effective only for property acquired from a decedent dying in 2010 because of the interaction of the following provisions: (1) pre-2010 Tax Relief Act which provided that the fair market value basis rules were not to apply to decedents dying after December 31, 2009, which provided that the modified carryover basis rules, and related rules, were to be effective for estates of decedents dying after December 31, 2009, which provided that the termination of the fair market value basis rules and application of the modified carryover basis rules, and related rules, were to be no longer effective for estates of decedents dying after December 31, 2010 (the EGTRRA sunset rule).

Notwithstanding the rules discussed below, the modified carryover basis rules (and other rules discussed above) can apply to property acquired from a decedent dying during 2010 (the 2010 modified carryover basis rules) if the executor makes the election. Under the election, for estate property and other property acquired from a decedent dying during 2010, the estate tax does not apply and the 2010 modified carryover basis rules do apply.

The 2010 Tax Relief Act repeals the provisions that, under EGTRRA, applied for purposes of determining basis in property acquired from a decedent who dies in 2010.

Thus, a recipient of property acquired from a decedent who dies after December 31, 2009 generally will receive date-of-death fair market value basis under the basis rules in effect in calendar-year 2009.

Accordingly, subject to the election referred to above, whether a decedent dies before, during or after calendar-year 2010, the fair market value basis rules apply (and not the modified carryover basis rules, nor any of the other related rules discussed above).

Executor Can Elect out of the Estate Tax and into Modified Carryover Basis Rules for Death in 2010

The Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the estate tax for estates of decedents dying after December 31, 2009, and repealed the generation-skipping transfer (GST) tax for generation-skipping transfers made after December 31, 2009.

EGTRRA included a sunset provision under which the estate and GST tax changes made by EGTRRA were scheduled to sunset for estates of decedents dying, and generation-skipping transfers made, after December 31, 2010.

However, EGTRRA repealed the fair market value basis rules for decedents dying in calendar year 2010, and EGTRRA replaced the fair market value basis rules with modified carryover basis rules under Code Sec. 1022, under which property acquired from a decedent was treated generally as property acquired by gift, with the basis of the property being the lesser of the property’s adjusted basis or fair market value on the date of death. EGTRRA also allowed an allocation of $1,300,000 ($60,000 for nonresident alien decedents) of basis increases among any properties that were owned (or treated as owned) by the decedent. For decedents other than nonresident aliens, the $1,300,000 was increased by unrealized losses and unused capital loss and net operating loss carryovers. An additional allocation of $3,000,000 of basis increases was allowed for properties deemed to be passing to a surviving spouse. The $1,300,000, $60,000 and 3,000,000 allocations were not permitted for certain types of property or in an amount that would cause the basis of any asset to exceed its date-of death-fair market value.

New Law
Notwithstanding 2010 Tax Relief Act (which reinstituted the estate tax and the step-up basis rules for estates of decedents dying in 2010, in the case of a decedent dying after December 31, 2009 and before January 1, 2011, the executor is allowed to elect to apply the Code as though the amendments made by 2010 Tax Relief Act do not apply with respect to the estate tax and with respect to property acquired or passing from the decedent within the meaning of Code Sec. 1014(b).

Thus, in the case of a decedent who dies during 2010, the election allows the executor of the decedent’s estate to elect to apply the Code as if the estate tax as provided by the 2010 Tax Relief Act and the basis step-up rules described above had not been enacted. In other words, instead of applying the estate tax as provided by the 2010 Tax Relief Act and the basis step-up rules, the executor can elect to have the rules for 2010 law, as enacted under EGTRRA apply. Therefore, in general, if the election is made, the estate is not subject to estate tax, and the basis of assets acquired from the decedent is determined under the modified carryover basis rules under Code Sec. 1022.

This election has no effect on the continued applicability of the generation-skipping transfer (GST) tax.

The election is made at the time and in the manner as IRS provides. An election, once made, is revocable only with the consent of IRS.

Extensions of Time Allowed for Filing Most 2010 Estate and GST Tax Returns, Paying Estate Tax, and Making Disclaimers

For a disclaimer of property passing by reason of a decedent’s death to meet the requirements for a “qualified disclaimer,” the disclaimer must be made within nine months of the decedent’s death.

The 2010 Tax Relief Act provides that, for estates of decedents dying after December 31, 2009, and before date of enactment of the 2010 Tax Relief Act, the due date for (1) filing an estate tax return, (2) paying the estate tax, and (3) making a disclaimer of an interest in property passing by reason of the decedent’s death, is not earlier than the date which is nine months after date of enactment of the 2010 Tax Relief Act.

Likewise, the 2010 Tax Relief Act provides that, for generation-skipping transfers made after December 31, 2009, and before date of enactment of the 2010 Tax Relief Act, the due date filing any GST tax return (including any election required to be made on the return) is not earlier than the date which is nine months after date of enactment of the 2010 Tax Relief Act.

Amount of Estate Tax Exemption and GST Exemption is $5 million in 2010, 2011, and 2012, subject to an Inflation Adjustment in 2012

The Economic Growth and Tax Relief Reconciliation Act of 2001 increased the “applicable exclusion amount” (the amount exempted from estate tax by the “applicable credit amount,” also known as the unified credit) on a phased-in schedule. Under the phased-in schedule provided by EGTRRA, the applicable exclusion amount was $3.5 million for estates of decedents dying in 2007, 2008, or 2009.

Every individual is allowed an exemption from the generation-skipping transfer (GST) tax. Under pre-2010 Tax Relief Act law, the GST exemption amount was equal to the applicable exclusion amount for estate tax purposes.

The 2010 Tax Relief Act provides that, for estates of decedents dying after 2009, the applicable exclusion amount is the sum of (1) the “basic exclusion amount” (defined below) and (2) in the case of a surviving spouse, the “deceased spousal unused exclusion amount.”

For estates of decedents dying after December 31, 2010, the basic exclusion amount is $5 million.

For estates of decedents dying after 2011, the $5 million basic exclusion amount will be increased by an amount equal to:

$5 million, multiplied by
the cost-of-living adjustment determined under Code Sec. 1(f)(3) for the year of the decedent’s death by substituting “calendar year 2010” for “calendar year 1992” in Code Sec. 1(f)(3)(B).

If any amount as adjusted under the above formula is not a multiple of $10,000, the amount will be rounded to the nearest multiple of $10,000.

The 2010 Tax Relief Act equates the amount of the GST tax exemption to the “basic exclusion amount” (i.e., $5 million, indexed for inflation after 2011, without regard to the “deceased spousal unused exclusion amount”), instead of the applicable exclusion amount.” Thus, up to $5 million in GST exemption may be allocated to a trust created of funded during 2010, depending on the amount of the exemption used by the taxpayer before 2010. The $5 million GST exemption is available in 2010 regardless of whether the executor of the estate of a decedent dying in 2010 makes the election to be subject to the estate tax and the carryover basis rules.

Under the 2010 Tax Relief Act, the sunset of the EGTRRA estate and GST tax provisions-which had been scheduled to apply to estates of decedents dying, and transfers, after December 31, 2010-will apply to estates of decedents dying, and transfers, after December 31, 2012.

Thus, absent further legislation, the applicable exclusion amount for estates of decedents dying after 2012, and the GST exemption for transfers after 2012, will be $1 million (the applicable exclusion amount that, under pre-EGTRRA law, had been scheduled to apply in 2006 and later years.)

Effective for estates of decedents dying, and transfers, after December 31, 2009.

Top Estate and Gift Tax Rate is 35% in 2010, 2011, and 2012

For estates of decedents dying, and gifts made, before 2010, the gift tax rates and the estate tax rates were set forth in a single graduated rate schedule. For estates of decedents dying, and gifts made, in 2007, 2008, or 2009, the maximum estate and gift tax rate was 45%.

The 2010 Tax Relief Act provides that, for estates of decedents dying after December 31, 2009, the maximum estate tax rate is 35%. This rate applies to transfers exceeding $500,000.

The estate tax exemption for estates of decedents dying in 2010, 2011, or 2012 is $5 million (subject to an inflation adjustment in 2012). Thus, the estate tax rate for estates of decedents dying in 2010, 2011, or 2012 is a flat 35% on transfers in excess of the $5 million applicable exclusion amount.

The gift tax exemption is the same as the estate tax exemption after 2010. Thus, the gift tax rate for gifts made after 2010 is a flat 35% on transfers in excess of the applicable exclusion amount. This is also the top rate that applied to gifts made in 2010, under the separate gift tax rate schedule provided by EGTRRA.

Thus, absent further legislation, the maximum estate and gift tax rate for estates of decedents dying, and gifts made, after 2012 will be 55%, and the benefits of the graduated estate and gift tax rate schedule will be phased out for taxable transfers exceeding $10 million.

Estate Tax Exclusion is Made Portable Between Spouses for Decedents Dying after 2010, but GST Exemption is not Portable

A credit (the “unified credit”) is allowed against the estate tax imposed on U.S. citizens and residents. The credit is equal to the tentative tax on the “applicable exclusion amount,” determined under the estate tax rate schedule.

Pre-2010 Tax Relief Act law did not allow for any unused portion of a decedent’s applicable exclusion amount to be used by the estate of the decedent’s surviving spouse.

Under the 2010 Tax Relief Act, any applicable exclusion amount that remains unused as of the death of a spouse who dies after December 31, 2010 (the “deceased spousal unused exclusion amount”) generally is available for use by the surviving spouse, as an addition to the surviving spouse’s applicable exclusion amount.

Specifically, the 2010 Tax Relief Act provides that the “applicable exclusion amount” is the sum of (1) the “basic exclusion amount” ($5 million, subject to an adjustment for inflation for estates of decedents dying after 2011), and (2) the “deceased spousal unused exclusion amount.”

For the surviving spouse of a deceased spouse dying after December 31, 2010, the term “deceased spousal unused exclusion amount” means the lesser of:

the basic exclusion amount ($5 million, subject to an adjustment for inflation for estates of decedents dying after 2011), or
the excess of:
- the basic exclusion amount of the last deceased spouse dying after December 31, 2010, of the surviving spouse, over
- the amount of the tentative tax on the estate of the deceased spouse, determined under the estate tax rate schedule.

A surviving spouse may use the deceased spousal unused exclusion amount in addition to the surviving spouse’s own $5 million exclusion for taxable transfers made during life or at death.

Assume that Husband 1 dies in 2011, having made taxable transfers of $3 million and having no taxable estate. An election (see below) is made on Husband 1’s estate tax return to permit Wife to use Husband 1’s deceased spousal unused exclusion amount. As of Husband 1’s death, Wife has made no taxable gifts. Thereafter, Wife’s applicable exclusion amount is $7 million (her $5 million basic exclusion amount plus $2 million deceased spousal unused exclusion amount from Husband 1), which she may use for lifetime gifts or for transfers at death.

If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by the surviving spouse is limited to the lesser of $5 million or the unused exclusion of the last deceased spouse. This so-called “last deceased spouse” limitation applies whether or not the last deceased spouse has any unused exclusion, and whether or not his estate makes a timely election to allow the surviving spouse to use the deceased spousal unused exclusion amount.

Assume the same facts as above, except the Wife later marries Husband 2. Husband 2 also predeceases Wife (thus becoming the “last deceased spouse”), having made $4 million in taxable transfers and having no taxable estate. An election is made on Husband 2’s estate tax return to permit Wife to use Husband 2’s deceased spousal unused exclusion amount. Although the combined amount of unused exclusion of Husband 1 and Husband 2 is $3 million ($2 million for Husband 1 and $1 million for Husband 2), only Husband 2’s $1 million unused exclusion is available for use by Wife, because the deceased spousal unused exclusion amount is limited to the lesser of the basic exclusion amount ($5 million) or the unused exclusion of the last deceased spouse (Husband 2) of the surviving spouse (Wife). Thus, Wife can only use Husband 2’s $1 million unused exclusion. Thereafter, Wife’s applicable exclusion amount is $6 million (her $5 million basic exclusion amount plus $1 million deceased spousal unused exclusion amount from Husband 2), which she may use for lifetime gifts or for transfers at death.

The Committee Report also provides the following example of how the deceased spousal unused exclusion amount works when the surviving spouse remarries, and then predeceases her second spouse.

Assume the same facts as above, except that Wife predeceases Husband 2. Following Husband 1’s death, Wife’s applicable exclusion amount is $7 million (her $5 million basic exclusion amount plus $2 million deceased spousal unused exclusion amount from Husband 1). Wife made no taxable transfers and has a taxable estate of $3 million. An election is made on Wife’s estate tax return to permit Husband 2 to use Wife’s deceased spousal unused exclusion amount, which is $4 million (Wife’s $7 million applicable exclusion amount less her $3 million taxable estate). Under the provision, Husband 2’s applicable exclusion amount is increased by $4 million, i.e., the amount of Wife’s deceased spousal unused exclusion amount.

Election by deceased spouse’s estate to allow surviving spouse’s estate to use deceased spousal unused exclusion amount.

A deceased spousal unused exclusion amount may not be taken into account by a surviving spouse unless the executor of the estate of the deceased spouse files an estate tax return on which the amount is computed, and makes an election on the return that the amount may be taken into account by the surviving spouse. The election, once made, is irrevocable. No election may be made if the estate tax return of the deceased spouse is filed after the due date (including extensions) for filing the return.

The election must be made on an estate tax return of the deceased spouse, regardless of whether the estate of the deceased spouse is otherwise required to file an estate tax return.

IRS May Examine Prior Returns After Expiration of Period of Limitations
In spite of any Code Sec. 6501 period of limitation for assessing estate or gift tax with respect to a predeceased spouse, IRS may examine a return of the deceased spouse after the period of limitation has expired, in order to determine the deceased spousal unused exclusion amount available for use by the surviving spouse.

IRS to Issue Regs
The 2010 Tax Relief Act directs IRS to issue regs that may be necessary or appropriate to carry out the rules on the deceased spousal unused exclusion amount.

GST Exemption is not Portable
The 2010 Tax Relief Act re-defines the amount of the generation-skipping transfer (GST) tax exemption from the “applicable exclusion amount” to the “basic exclusion amount” ($5 million, indexed for inflation after 2011). Thus, the 2010 Tax Relief Act provision allowing portability of the estate tax applicable exclusion amount does not allow a surviving spouse to use the unused GST exemption of a predeceased spouse.

Estate Tax Return Filing Threshold is Tied to Basic Exclusion Amount ($5 Million)
The Tax Relief Act provides that the estate of a U. S. citizen or resident must file an estate tax return if the gross estate exceeds the “basic exclusion amount” (i.e., $5 million, subject to an adjustment for inflation after 2011).

Thus, the estate of a U. S. citizen or resident dying after December 31, 2010, must file an estate tax return if the gross estate exceeds $5 million (as indexed for inflation after 2011), even if the decedent’s applicable exclusion amount is greater than $5 million as a result of the deceased spousal unused exclusion amount.

Portability Rules Will Sunset After 2012
Thus, absent further legislation, the rules allowing the portability of the applicable exclusion amount between spouses will not apply to estates of decedents dying after December 31, 2012.

Gift Tax Exemption Will be Reunified With Estate Tax Exemption for Gifts Made After 2010, but Stays Unchanged at $1 Million for Gifts Made in 2010

Before 2004, the estate and gift taxes were unified, so that a single exemption amount (the amount excluded from tax by the unified credit) applied for purposes of determining the tax on cumulative taxable transfers made by a taxpayer during his lifetime and at death. As a result of the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001, the estate and gift taxes were no longer unified after 2003.

For 2004 through 2009, the exemption amount allowed for estate tax purposes was higher than the exemption amount for gift tax purposes. In 2009, the exemption amount was $3.5 million for estate tax purposes, and $1 million for gift tax purposes.

For gifts made after December 31, 2010, the gift tax is reunified with the estate tax, with an applicable exclusion amount of $5 million.

Because this change applies to gifts made after December 31, 2010, the gift tax exclusion amount for gifts made in 2010 remains at $1 million.

Estate and GST Tax Changes Made by EGTRRA That Had Been Scheduled to Sunset After 2010 are Now Scheduled to Sunset After 2012

Under the 2010 Tax Relief Act, the sunset of the EGTRRA estate and GST tax provisions-which had been scheduled to apply to estates of decedents dying, and generation-skipping transfers made, after December 31, 2010 – is extended to apply to estates of decedents dying, and generation-skipping transfers made, after December 31, 2012.

Absent further legislation, the above-described rules will sunset for estates of decedents dying, and generation-skipping transfers made, after 2012.

Date-Of-Death Rates are Used in Determining Gift Tax On, and Unified Credit Allowable for, Decedent’s Post-1976 Gifts

In computing a decedent’s estate tax, the tentative estate tax is reduced by the total amount of gift tax that would have been payable with respect to gifts made by the decedent after 1976, if the Code Sec. 2001(c) estate and gift tax rate schedule in effect on the date of the decedent’s death had been applicable at the time of the gifts.

A credit (the “unified credit”) is allowed against the gift tax imposed on gifts made by a U.S. citizen or resident. The amount of the unified credit allowable against the gift tax on gifts made in a calendar year is reduced by the sum of all amounts allowable as a credit to the donor in preceding calendar periods.

The 2010 Tax Relief Act clarifies the rules on the computation of estate and gift taxes, to reflect differences in the unified credit resulting from different tax rates.

The 2010 Tax Relief Act provides that, for purposes of computing the amount by which a decedent’s tentative estate tax is reduced for the gift tax on the decedent’s post-1976 gifts, the Code Sec. 2001(c) tax rates in effect at the decedent’s death (instead of the tax rates in effect at the time of the gifts) are used to compute both:

the gift tax imposed on the gifts (as under pre-2010 Tax Relief Act law), and
the gift tax unified credit. For this purpose, the date-of-death tax rates are used in computing (a) the amount of the unified credit allowable against the post-1976 gifts, and (b) the sum of the amounts allowed as a credit for all preceding periods (which reduces the allowable unified credit).

The 2010 Tax Relief Act also provides that, for purposes of applying the rule that the amount of the unified credit allowable against the gift tax on gifts made in a calendar year is reduced by the sum of all amounts allowable as a credit to the donor in preceding calendar periods, the gift tax rates that are in effect for the calendar year of the gift (instead of the rates in effect for the preceding calendar periods) are used in determining the amounts allowable as a credit for all preceding calendar periods.

Effective for estates of decedents dying, and gifts made, after December 31, 2009.

Reporting Requirements Relating to the Carryover Basis Rules are Repealed

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) repealed the estate tax for estates of decedents dying after 2009, but the 2010 Tax Relief Act retroactively reinstates the estate tax for 2010, 2011, and 2012.

Property acquired from decedents dying after 2009, EGTRRA would have provided a modified carryover basis regime in place of the step-up (or step-down) in basis rules that apply to property acquired from decedents dying before 2010. Under the modified carryover basis rules provided by EGTRRA, an executor would have been permitted to allocate a $1.3 million “aggregate basis increase” among the decedent’s assets. The 2010 Tax Relief Act repeals the modified carryover basis rules that would have been provided by EGTRRA, and reinstates the step-up in basis rules for property acquired from decedents dying in 2010 and later years.

In conjunction with the repeal of the estate tax and the addition of the modified carryover basis rules, EGTRRA would have imposed certain reporting requirements. Specifically:

EGTRRA would have replaced the pre-2010 estate tax return filing requirements with a requirement that an executor file an information return with IRS if the value of property (other than cash) acquired from a decedent exceeded $1.3 million. For each asset acquired from the decedent, the information required to be reported on the return would have included the identity of the recipient, a description of the property, the decedent’s adjusted basis in the property, the decedent’s holding period, sufficient information to determine whether any gain on the sale of the property would be treated as ordinary income, and any basis increase allocated to the property. The information return would have had to be filed with the income tax return for the decedent’s tax year or a later date to be specified in regs; and
EGTRRA would have required every person who was required to file a gift tax return after 2009 to furnish, to each person whose name was required to be set forth in the return (other than the person required to file the return), a written statement showing (a) the name, address, and phone number of the person required to make the return, and (b) the information specified in the return with respect to property received by the person required to receive the statement.

The 2010 Tax Relief Act repeals the reporting requirements (and penalties for failure to comply with the reporting requirements) that would have applied to estates of decedents dying in 2010, under EGTRRA, do not apply. Instead, the Code Sec. 6018 estate tax return filing requirements that applied to estates of decedents dying before 2010 continue to apply to estates of decedents dying after 2009.

For an election which may be made by the executor of the estate of a decedent dying in 2010 to apply the Code as if the estate tax were not reinstated and as if the carryover basis rules were not repealed, the reporting requirements (and penalties) that would have applied under EGTRRA continue to apply to that estate.

Business Provisions

Expensing and Additional First-Year Depreciation in The 2010 Tax Relief Act – Overview

The recently enacted 2010 Tax Relief Act includes a wide-ranging assortment of tax changes affecting both individuals and business. On the business side, two of the most significant changes provide incentives for businesses to invest in machinery and equipment by allowing for faster cost recovery of business property. Here are the details.

Expansion and Extension of Additional First-Year Depreciation
Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008, 2009, or 2010 (2011 for certain property), by permitting the first-year write-off of 50% of the cost. The new law extends and temporarily increases this additional first-year depreciation provision for investment in new business equipment. For investments placed in service after September 8, 2010 and through December 31, 2011 (through December 31, 2012 for certain longer-lived and transportation property), the new law provides for 100% additional first-year depreciation. In other words, the entire cost of qualifying property placed in service during that time frame can be written off, without limit. Note that even though the legislation did not take shape in Congress until mid-December of 2010, the effective date of this provision was made retroactive, to include qualifying property placed in service after September 8, 2010.

Fifty percent additional first-year depreciation will apply again in 2012.

The Act extends through 2012 the election to accelerate the AMT credit instead of claiming additional first-year depreciation.

The new law leaves in place the existing rules as to what kinds of property qualify for additional first-year depreciation. Generally, the property must be depreciable property with a recovery period of 20 years or less; water utility property; computer software; or qualified leasehold improvements. Also the original use of the property must commence with the taxpayer – used machinery does not qualify.

Enhanced Small Business Expensing (Section 179 Expensing)
Generally, the cost of property placed in service in a trade or business cannot be deducted in the year it is placed in service if the property will be useful beyond the year. Instead, the cost is “capitalized” and depreciation deductions are allowed for most property (other than land), but are spread out over a period of years. However, to help small businesses quickly recover the cost of capital outlays for qualifying personal property, small business taxpayers can elect to write off these expenditures in the year of acquisition instead of recovering the costs over time through depreciation. The expense election is made available, on a tax year by tax year basis, under Section 179 of the Internal Revenue Code, and is often referred to as the “Section 179 election” or the “Code Section 179 election.” The new law makes three important changes to the Code Section 179 expense election.

First, the new law provides that for tax years beginning in 2012, a small business taxpayer will be allowed to write off up to $125,000 (indexed for inflation) of capital expenditures subject to a phaseout (i.e., gradual reduction) once capital expenditures exceed $500,000 (indexed for inflation). The new maximum expensing amount and phaseout level for tax years beginning in 2012 is actually lower than the levels in effect for tax years beginning in 2010 and 2011 (maximum expensing amount of $500,000, and a phaseout level of $2,000,000). For tax years beginning after 2012, the maximum expensing amount will drop to $25,000 and the phaseout level will drop to $200,000.

Second, the rule which treats off-the-shelf computer software as qualifying property is extended through 2012.

Finally, the new law extends, through 2012, the provision permitting a taxpayer to amend or irrevocably revoke a Code Sec. 179 expense election for a tax year without IRS’s consent.

100% Bonus Depreciation is Allowed After September 8, 2010 and Before January 1, 2012

Under Code Sec. 168(k), “qualifying property” is allowed additional depreciation (bonus depreciation) in the year that the property is placed in service (with corresponding reductions in basis and, thus, reductions of the regular depreciation deductions otherwise allowed in the placed-in-service year and in later years).

The rule discussed above for qualified property does not apply to classes of property for which, under Code Sec. 168(k)(2)(D)(iii), the taxpayer elects not to apply Code Sec. 168(k) (an “election-out”).

Under pre 2010 Tax Relief Act law, the percentage of depreciable basis allowed as bonus depreciation was 50% for all qualified property.

The following are the requirements for qualified property under Code Sec. 168(k)(2):

the property must be of a qualifying type; i.e., generally, most machinery, equipment or other tangible personal property; most computer software; and certain leasehold improvements;
the property must not be either property that must be depreciated under the alternative depreciation system of “qualified New York Liberty Zone leasehold improvement property”);
the property must not be the subject of certain disqualifying transactions involving users other than the taxpayer or persons related to the taxpayer or the other users;
the property’s original use must generally begin with the taxpayer after December 31, 2007;
the property must meet a timely-placed-in-service requirement (see below); and
the property must meet a timely acquisition requirement (see below).

Under pre-2010 Tax Relief Act law, the timely-placed-in-service requirement was that the property had to be placed in service by the taxpayer before January 1, 2011, except for certain aircraft and certain long-production-period property that had to be placed in service before January 1, 2012. However, long-production-period property could qualify for the December 31, 2011 placed-in-service deadline only to the extent of adjusted basis attributable to manufacture, construction or production before January 1, 2011.

Under pre-2010 Tax Relief Act law, the timely acquisition requirement was satisfied if the property was acquired by the taxpayer either (1) after December 31, 2007 and before January 1, 2011, but only if no written binding contract for the acquisition was in effect before January 1, 2008, or (2) under a written binding contract entered into after December 31, 2007 and before January 1, 2011. For a taxpayer manufacturing, constructing or producing property for its own use, the timely acquisition requirement was treated as met if the taxpayer began the manufacture, construction or production after December 31, 2007 and before January 1, 2011 (the “self-constructed” property rule).

New Law
The 2010 Tax Relief Act provides that the bonus depreciation percentage is 100% (instead of 50%, see above) for “qualified property” (see the observations below) that is (1) placed in service after September 8, 2010 and before January 1, 2012 (before January 1, 2013 for the aircraft and long-production-period property discussed above) and (2) acquired by the taxpayer, under rules similar to the rules in Code Sec. 168(k)(2)(A)(ii) and Code Sec. 168(k)(2)(A)(iii) (see the Committee Report excerpt below), after September 8, 2010 and before January 1, 2012. (Code Sec. 168(k)(5) as amended by 2010 Tax Relief Act §401(b)).

The 2010 Tax Relief Act changed the general “before January 1, 2011” deadline in the timely-placed-in-service requirement for “qualified property” (above) to “before January 1, 2013” and the “before January 1, 2012” deadline in the timely-placed-in-service requirement for certain aircraft and long-production-period property (above) to “before January 1, 2014.” Also, the “before January 1, 2011” deadline in the progress expenditure rule (above) was changed to “before January 1, 2013.” In contrast, under Code Sec. 168(k)(5) (above) the general deadline for placing qualified property eligible for 100% bonus depreciation is “before January 1, 2012” but, for the aircraft and long-production-period property, “before January 1, 2013.” However, there is no separate progress expenditure rule for property eligible for 100% bonus depreciation. Thus, for the aircraft and long-production-period property, the entire adjusted basis of the property is eligible for the 100% bonus depreciation if the “before January 1, 2013” deadline is met.

The 2010 Tax Relief Act changed the “before January 1, 2011” deadline in the timely acquisition requirement for “qualified property,” including the deadline in the self-constructed property rule, to “before January 1, 2013.” In contrast, under Code Sec. 168(k)(5) (above) the deadline for acquiring property eligible for 100% bonus depreciation is “before January 1, 2012.”

According to Congress, a consequence of the requirement that property eligible for the 100% bonus depreciation be acquired under rules similar to the rules in Code Sec. 168(k)(2)(A)(ii) and Code Sec. 168(k)(2)(A)(iii) is that property acquired under a written binding contract entered into after December 31, 2007 is qualified property for purpose of the 100% bonus depreciation assuming all other requirements are met.

Code Sec. 179 Expensing Limit Will Increase to $125,000 and Phaseout Threshold to $500,000, Indexed for Tax Years Beginning in 2012

Subject to certain limitations, taxpayers can elect to treat the cost of any section 179 property placed in service during the tax year as an expense which is not chargeable to capital account, and, thus, allowed as a deduction for the tax year in which the section 179 property is placed in service.

Under pre-2010 Tax Relief Act law, the deductible Code Sec. 179 expense could not exceed $250,000 in the case of a tax year beginning in 2008 or 2009, and $500,000 (dollar limitation) in the case of a tax year beginning in 2010 or 2011. The maximum deductible expense had to be reduced (i.e., phased out, but not below zero) by the amount by which the cost of section 179 property placed in service during a tax year beginning in 2008 or 2009 exceeded $800,000, and during a tax year beginning in 2010 or 2011, exceeded $2,000,000 (beginning-of-phaseout amount). The dollar limitation and phaseout amount were not adjusted for inflation.

Under pre-2010 Tax Relief Act law, for a tax year beginning in 2010 or 2011, subject to a dollar limitation and a carryover limitation, “section 179 property” included up to $250,000 of the cost of “qualified real property.”

Under pre-2010 Tax Relief Act law, for tax years beginning after 2011, the dollar limitation (discussed above) was to be $25,000 and the phaseout amount (discussed above) was to be $200,000. The $25,000 and $200,000 amounts were not to be adjusted for inflation.

In 2012, T, a calendar-year taxpayer, places into service section 179 property with a cost of $215,000. Under pre-2010 Tax Relief Act law, the maximum amount T could elect to expense for 2012 was $10,000: $25,000 (maximum expense for 2012) – $15,000 (the amount by which the cost of section 179 property placed in service, $215,000, exceeds the phaseout amount for 2012, $200,000).

The 2010 Tax Relief Act provides that, for tax years beginning in 2012:

the dollar limitation on the Code Sec. 179 expense deduction will be $125,000 (Code Sec. 179 (b)(1)(C) as amended by 2010 Tax Relief Act §402(a)), and
the reduction in the dollar limitation will start to take effect when property placed in service in a tax year exceeds $500,000 (beginning-of-phaseout amount).

Thus, for tax years beginning in 2012, the maximum amount a taxpayer will be able to expense will be $125,000 of the cost of qualifying property placed in service for the tax year. The $125,000 amount will be reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $500,000.

Thus, for tax years beginning in 2012, the 2010 Tax Relief Act temporarily increases the maximum amount a taxpayer will be able to deduct under Code Sec. 179 to $125,000 of the cost of qualifying property placed in service for the tax year.

Thus $125,000 amount (discussed above) of qualified property that can be expensed will be reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2012 exceeds $500,000. Accordingly, for property placed in service in tax years beginning in 2012, the Code Sec. 179 deduction will phase out completely when the cost of the property exceeds $625,000 ($500,000 (phaseout amount) + $125,000 (dollar limitation)).

In 2012, T, a calendar-year taxpayer, places into service section 179 property with a cost of $215,000. The maximum amount T can elect to expense for 2012 is $125,000: $125,000 (maximum expense for 2012) – $0 (the amount by which the cost of section 179 property placed in service, $215,000, exceeds the phaseout amount for 2012, $500,000).

While the 2010 Tax Relief Act increases the dollar limitation and phaseout amount (to $125,000 and $500,000, respectively) for tax years beginning in 2012 from what they otherwise would have been under pre-2010 Tax Relief Act law ($25,000 and $200,000, as discussed above), those amounts will actually decrease from their 2010 and 2011 levels ($500,000 and $2,000,000, respectively).

The 2010 Tax Relief Act did not extend the temporary extension of the definition of qualifying property to include qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property (that applied for tax years beginning in 2010 or 2011).

Under the 2010 Tax Relief Act, the $125,000 and $500,000 amounts (discussed above) will be indexed for inflation.

For tax years beginning after 2012, the 2010 Tax Relief Act provides for a $25,000 dollar limitation on the Code Sec. 179 expense deduction, and a $200,000 beginning-of-phaseout amount.

Thus, for tax years beginning in 2013, and thereafter, the maximum amount a taxpayer will be able to expense will be $25,000 of the cost of qualifying property placed in service for the tax year. The $25,000 amount will be reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $200,000.

Thus, the reversion to the $25,000 dollar limitation and $200,000 beginning-of-phaseout amount will take effect for tax years beginning in 2013 and later, one year later than under pre-2010 Tax Relief Act law.

15-Year MACRS Depreciation for Certain Building Improvements and Restaurants is Extended to Apply to Property Placed in Service Before January 1, 2012

The rules that in most situations assign a recovery period (i.e., depreciation period) to the various types of MACRS property are known as the General Depreciation System (GDS).

Assets that are nonresidential real property-generally, nonresidential buildings and their structural components-are depreciated on the straight-line method, over a 39-year GDS recovery period.

However, under pre-2010 Tax Relief Act law, a building improvement that was “qualified leasehold improvement property” placed in service before January 1, 2010 was depreciated on the straight-line method, over a 15-year GDS recovery period.

Similarly, a building improvement that was “qualified retail improvement property” placed in service before January 1, 2010 was depreciated on the straight-line method, over a 15-year GDS recovery period.

Also, a building improvement or a building (see below) that was “qualified restaurant property” placed in service before January 1, 2010 was depreciated on the straight-line method, over a 15-year GDS recovery period.

Taxpayers are sometimes required to, or may elect to, depreciate MACRS property under the alternative depreciation system (ADS) instead of under the GDS. Nonresidential real property is depreciated over a 40-year recovery period for ADS purposes.

However, under pre-2010 Tax Relief Act law, qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property placed in service before January 1, 2010 were depreciated over a 39-year recovery period for ADS purposes.

The 2010 Tax Relief Act extends the rules discussed above for qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property for two years by changing the date before which the three types of property must be placed in service from January 1, 2010 to January 1, 2012.

Thus, the 15-year GDS recovery period and 39-year ADS recovery period continue in effect for qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property placed in service before January 1, 2012, but a 39-year GDS recovery period and 40-year ADS recovery period will apply to qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property in service after December 31, 2011.

Increase in First-Year Depreciation Cap for Cars That are “Qualified Property” is Extended Through 2012

Code Sec. 280F(a) imposes dollar limits on the depreciation deductions (including deductions under the Code Sec. 179 expensing election) that can be claimed with respect to “passenger automobiles.” The dollar limits are adjusted annually from a base amount to reflect changes in the automobile component of the Consumer Price Index (CPI). Generally, for passenger automobiles placed in service in 2010, the adjusted first-year limit is $3,060. For passenger automobiles built on a truck chassis (“qualifying trucks and vans”) a different CPI component is used, and for 2010 the adjusted first-year limit is $3,160.

For any passenger automobile that is “qualified property” and which is not subject to a taxpayer election to decline the bonus depreciation and AMT depreciation relief otherwise available for “qualified property” under Code Sec. 168(k), the above rules apply, except that the applicable first-year depreciation limit is increased by $8,000 (not indexed for inflation).

Under pre-2010 Tax Relief Act law, qualified property did not include property placed in service after December 31, 2010, except for certain aircraft and certain long-production-period property that had, instead, a December 31, 2011 paced-in-service deadline.

The 2010 Tax Relief Act provides that the placed-in-service deadline for “qualified property” is December 31, 2012 (December 31, 2013 for the aircraft and long-production-period property discussed above).

Thus, for a passenger automobile that satisfies the other requirements (see below) for qualified property (and is not subject to the election to decline bonus depreciation and AMT depreciation relief), the 2010 Tax Relief Act extends the placed-in-service deadline for the $8,000 increase in the first-year depreciation limit from December 31, 2010 to December 31, 2012. The December 31, 2013 deadline that applies to the aircraft and long-production-period property discussed above is not available for passenger automobiles for the reasons discussed above concerning the December 31, 2011 deadline under pre-2010 Tax Relief Act law.

Property is “ qualified property” if it satisfies the definitional requirements and is not subject to certain ineligibility rules. As applied to passenger automobiles, the effect of these requirements are ineligibility rules is that in most instances a passenger automobile that satisfies the December 31, 2012 placed-in-service deadline will be eligible for the $8,000 increase in the first-year depreciation limit if (1) the automobile’s original use begins with the taxpayers after December 31, 2007, (2) the automobile is predominantly used by the taxpayer in his business and (3) the automobile is acquired by the taxpayer after December 31, 2007.

On October 15, 2011, T, a calendar year taxpayer, places a new passenger automobile into service in his business. Assume that the vehicle is “qualified property” (and an election to decline bonus depreciation and AMT depreciation relief does not apply to the vehicle. T is allowed first-year depreciation for 2010 of no more than $11, 060 (the $3,060 amount discussed above-assuming, just for illustration purposes, that it remains the same for 2011-plus $8,000).

The facts are the same as above, except that in 2010 T uses the passenger automobile 80% for business and 20% for personal activities. Because the passenger auto depreciation limits are proportionally reduced to the extent that a vehicle is not exclusively used in business, T is allowed first-year depreciation for 2011 of no more than $8,848 (80% x $11,060).

Election to Expense Qualified Environmental Remediation Expenditures is Extended to Include Expenditures Paid or Incurred Before January 1, 2012

Taxpayers may elect to expense qualified environmental remediation expenditures, i.e., expenditures that would otherwise be chargeable to capital account and were incurred in connection with the abatement or control of “hazardous substances” at a “qualified contaminated site.” Under pre-2010 Tax Relief Act law, the election to deduct qualified expenditures in the year paid or incurred applied for eligible expenditures paid or incurred before January 1, 2010. That is, under Code Sec. 198, the election to expense qualified environmental remediation costs did not apply expenditures paid or incurred after December 31, 2009.

The 2010 Tax Relief Act extends the pre-2010 Tax Relief Act provision permitting the expensing of qualified environmental remediation expenditures for two years to include expenditures paid or incurred before January 1, 2012. Specifically, The 2010 Tax Relief Act does this by striking the December 31, 2009 termination date for the expensing election for environmental remediation expenditures and replacing it with a December 31, 2011 termination date. Thus, under the 2010 Tax Relief Act, Code Sec. 198 will not apply to expenditures paid or incurred after December 31, 2011.

Research Credit is Retroactively Extended to Apply to Amounts Paid or Incurred Before January 1, 2012

Under pre-2010 Tax Relief Act law, a taxpayer was entitled to a research credit for qualifying amounts paid or incurred before January 1, 2010.

The credit was generally equal to 20% of the amount by which the taxpayer’s qualified research expenses exceeded a specific base amount unless the taxpayer elected the alternative simplified credit. Additional components of the research credit included the separately computed “university basic research credit”, equal to 20% of the basic research payments to qualified research organizations less the “qualified organization base period amount,” and a separately computed “energy research consortium credit” based on amounts paid or incurred to an energy research consortium. Unlike the other components of the research credit, the energy research consortium credit applied for all qualified expenditures, not just those in excess of a base amount.

The 2010 Tax Relief Act extends the research credit for two years by striking the December 31, 2009 expiration date of the research credit (including the university basic research credit and the energy research consortium credit) and replacing that date with December 31, 2011.

Because the extension of the research credit is retroactive to include amounts paid or incurred after December 31, 2009, taxpayers, such as fiscal year corporations that paid or incurred amounts for research credits in 2010 and already filed returns for a fiscal year that includes part of 2010, should consider filing an amended return to claim a refund for the amount of the additional tax paid because of not claiming amounts now eligible for the credit.

Unless the research credit is extended further by future legislation, the credit will not apply to amounts paid or incurred after December 31, 2011.

Work Opportunity Credit is Extended for Individuals from Most Targeted Groups Who Begin Work for an Employer Through December 31, 2011

A work opportunity tax credit (WOTC) is available on an elective basis to an employer for a percentage of limited amounts of wages paid or incurred by the employer to individuals who belong to a “targeted group.”

Code Sec. 51(c)(4)(B), as in effect before the enactment of the 2010 Tax Relief Act, stated that the WOTC was not available for wages paid or incurred by an employer to an individual who began work for the employer after August 31, 2011.

Code Sec. 51(c)(4)(B) does not apply to the two classes of employees that are included in the target group consisting of “Hurricane Katrina employees.” Instead, an employer could claim a credit for an individual in one class of Hurricane Katrina employees only if the individual was hired on or before August 27, 2009 and for an individual in the other class only if the individual was hired on or before December 31, 2005.

The WOTC is also available for wages paid or incurred by an employer to unemployed veterans and disconnected youth who begin work for an employer in 2009 and 2010.

The 2010 Tax Relief Act extends the WOTC for four months (for individuals who began work for an employer after August 31, 2011 and before January 1, 2012, by providing that the term “wages” (for purposes of determining the amount of the WOTC) does not include any amount paid or incurred to an individual who begins work for the employer after December 31, 2011.

The last day a taxpayer can employ a qualifying individual and be eligible to get a credit for wages paid or incurred to that individual is December 31, 2011. However, subject to applicable percentage and dollar-amount limitations, the credit is, for most targeted groups, available for any eligible wages paid or incurred to that individual for service rendered during the period ending one year after the date that the individual was first employed, even though, for employees hired after December 31, 2010, the last day of the one-year period is after December 31, 2011.

Energy Efficient Home Credit for Eligible Contractors is Retroactively Extended Through December 31, 2011

Under pre-2010 Tax Relief Act law, an eligible contractor could claim, as part of the general business credit for the tax year, a credit for each qualified new energy efficient home that the contractor constructed and which was acquired by a person from the contractor for use as a residence during the tax year.

An “eligible contractor” for this purpose was the person who constructed the qualified new energy efficient home, or for a qualified new energy efficient home which was a manufactured home, the manufactured home producer.

As indicated by Notice 2008-35, for this purpose, a qualified energy efficient home was “acquired” from an eligible contractor for use as a residence if the person that constructed the home sold or leased the home to another person for use as a residence, but not if the person who constructed the home retained the home for use as a residence. A qualified energy efficient manufactured home was acquired directly from an eligible contractor for use as a residence if the person that produced the manufactured home sold or leased the manufactured home to another person for use as a residence. A qualified energy efficient manufactured home was acquired indirectly from an eligible contractor for use as a residence if the person that produced the manufactured home sold the manufactured home to an intermediary and the intermediary (or the last of multiple intermediaries) sold or leased the manufactured home to another person for use as a residence. A qualified energy efficient manufactured home was not acquired from an eligible contractor if the person that produced the manufactured home retained the manufactured home for use as a residence.

The credit was either $2,000 (for a 50% reduction in energy usage) or $1,000 (for a 30% reduction in energy usage). The credit was only available for qualified new energy efficient homes substantially completed after December 31, 2005, and acquired after December 31, 2005 and before January 1, 2010. Thus, the credit did not apply to any qualified new energy efficient home acquired after December 31, 2009.

The 2010 Tax Relief Act retroactively restored and extended the energy efficient home credit for two years, so that it does not apply to qualified new energy efficient homes acquired after December 31, 2011. Thus, the 2010 Tax Relief Act extends the credit to homes purchased before January 1, 2012.

Enhanced Charitable Deduction Rules are Retroactively Extended for Qualified Computer Contributions Made by Corporations Through 2011

A C Corporation (other than a personal holding company or “service organization”) that makes a “qualified computer contribution” of computer technology or equipment (software, computer or peripheral equipment, and fiber optic cable related to computer use) to a Code Sec. 170(b)(1)(A)(ii) exempt educational organization, a tax exempt organization that supports elementary and secondary education, or a public library for use in the U.S. for educational purposes related to the donee’s purpose or function may claim a deduction equal to the lesser of (a) the contributor’s basis plus half of the property’s appreciation (i.e. basis plus one-half of the fair market value (FMV) in excess of basis), or (b) twice the property’s basis.

Under pre-2010 Tax Relief Act law, the qualified computer contribution rules expired and were not applicable to any otherwise qualifying contributions made in tax years beginning after December 31, 2009.

Under the 2010 Tax Relief Act, the qualified computer contribution rules will not apply to contributions made during any tax year beginning after December 31, 2011 (rather than December 31, 2009), in other words, the Act extends the above rules to contributions made during tax years beginning after December 31, 2009, and before January 1, 2012.

Parity for Monthly Exclusion for Employer-Provided Transit Passes and Vanpooling Benefits with Employer-Provided Parking Continued Through 2011

For months beginning before February 17, 2009, an employer could exclude from an employee’s income a statutory amount of up to $100 a month ($120, as adjusted for inflation for 2009) for qualified transportation fringe benefits that the employer provided through transit passes and vanpooling. The 2009 Recovery Act temporarily raised the excludable amount to provide parity for these benefits with employer-provided parking benefits, which are excluded up to a statutory amount of $175 a month ($230, as adjusted for inflation for 2009 and 2010), for months beginning before January 1, 2011. Thus, for 2010, an employer may exclude from an employee’s income up to $230 a month for qualified transportation fringe benefits that the employer provides through transit passes and vanpooling, the same amount that an employer may exclude for qualified transportation fringe benefits that the employer provides through employer-provided parking.

The 2010 Tax Relief Act extends parity for another year. Thus, for any month beginning before January 1, 2012, the monthly exclusion limitation for employer-provided transit and vanpooling benefits is the same as for employer-provided parking.

IRS has yet to determine the maximum exclusion for 2011, but it will not be less than $230.

Rule That S Corporation’s Charitable Contribution of Property Reduces Shareholder’s Basis Only by Contributed Property’s Basis is Extended for Tax Years Beginning in 2010 or 2011

The 2006 Pension Protection Act amended the S corporation rules so that the decrease in a shareholder’s basis in his S corporation stock by reason of a charitable contribution made by the S corporation equals the shareholder’s pro rata share of the adjusted basis of the contributed property. Where this rule applies to limit the decrease in the basis resulting from the charitable contribution, the rule that limits the aggregate amount of losses and deductions that may be taken by the S corporation shareholder to his basis in the S corporation’s stock and debt does not apply to the extent of the excess of the shareholder’s pro rata share of the charitable contribution over the shareholder’s pro rata share of the adjusted basis of such property. These rules were originally effective for contributions made in tax years beginning after December 31, 2005 and before tax years beginning after December 31, 2007, but were later extended for tax years beginning in 2008 and 2009.

The 2010 Tax Relief Act extends the rule that the decrease in a shareholder’s basis in his S corporation stock by reason of a charitable contribution made by the S corporation equals the shareholder’s pro rata share of the adjusted basis of the contributed property for contributions in tax years beginning before January 1, 2012.

This means that the extension applies to contributions made in tax years beginning in 2010 and 2011.

Passthrough of Qualified Dividend Income by Partnerships is Extended Through 2012

Qualified dividend income received by noncorporate shareholders is taxed at the 0% or 15% maximum rates applicable to adjusted net capital gain. For a partnership, each partner’s distributive share of qualified dividend income received by the partnership is treated as qualified dividend income in the partner’s hands.

Thus, the qualified character of the dividends passes through to the partners, and the partners’ distributive shares of the partnership’s qualified dividend income is taxed at the maximum 0% or 15% maximum rates applicable to adjusted net capital gain.

The 2010 Tax Relief Act extends the above passthrough rule for partnership qualified dividend income for two additional years, so that they apply through tax years beginning before January 1, 2013.

This two-year extension parallels the extension of the rules taxing qualified dividend income at the 0% or 15% maximum rates applicable to adjusted net capital gain, and is effective for tax years beginning in 2011 and 2012.

Overview of the 2010 RIC Modernization Act

Introduction
The 2010 RIC Modernization Act makes numerous changes to the taxation of regulated investment companies (RICs) and their shareholders. In general, RICs are electing domestic corporations that either meet (or are excepted from) certain registration requirements under the Investment Company Act of 1940, that derive at least 90% of their ordinary income from specified sources considered passive investment income, that have a portfolio of investments that satisfy certain diversification requirements, and meet certain other requirements. RICs include open-end companies (mutual funds), which have a continuously changing number of shares that are bought from, and redeemed by, the company and closed-end companies, that have a fixed number of shares that are normally traded on national securities exchanges or in the over-the-counter market and are not redeemable upon shareholder demand. This overview provides the background for specific changes included in the 2010 RIC Modernization Act and then briefly describes the changes with cross references to the paragraphs where the changes are discussed.

Background
Under pre-2010 RIC Modernization Act law, at least 90% of a RIC’s gross income had to consist of dividends, interest, payments relating to securities loans, and gains from the sale or other disposition of stock or securities (defined under section 2(a)(36) of the Investment Company Act of 1940) or foreign currencies, or other income (including gains from options, futures or forward contracts) from its business of investing in such stock, securities, or currencies, and net income derived from investment in qualified publicly traded partnerships. Pre-2010 RIC Modernization Act law included limited relief for RICs that failed to satisfy the assets tests.

New Law
The 2010 RIC Modernization Act provides additional relief provisions for a RIC to avoid disqualification for failing the income or assets test.

Background
If a RIC distributes at least 90% of its net ordinary income and net tax-exempt interest to its shareholders, a deduction for dividends paid is allowed to the RIC in computing its tax. Thus, no corporate income tax is imposed on income distributed to its shareholders. However, dividends that were preferential among members of the same class of shares were not taken into account. Dividends of a RIC generally are includible in the income of the shareholders. In addition, a RIC can pass through the character of (1) its long-term capital gain income, by paying capital gain dividends and (2) in certain cases, tax-exempt interest, by paying exempt-interest dividends. A RIC may also pass through certain foreign tax credits and credits on tax-credit bonds, as well as the character of certain other income received by the RIC. Under pre-2010 RIC Modernization Act law, a RIC could distribute exempt-interest dividends if at least 50% of the RICs assets consisted of tax-exempt state and local bonds. Similarly, a RIC could elect to pass through to shareholders certain foreign tax credits only if more than 50% of the value of the RIC’s total assets at the close of the tax year consisted of stock and securities of foreign corporations. In addition, under pre-2010 RIC Modernization Act law, designation had to be made in a notification to shareholders not later than 60 days after the close of the RIC’s tax year. Because RICs must satisfy their distribution requirements, they are allowed to distribute spillover dividends after the close of the tax year. In addition, if there was a determination that a RIC has a tax deficiency for an earlier tax year, a RIC could distribute a deficiency dividend under pre-2010 RIC Modernization Act law at the cost of paying an interest charge and incurring a penalty.

New Law
The 2010 RIC Modernization Act allows an upper-tier RIC in a fund-of-funds structure to distribute exempt-interest dividends and pass through the foreign credit from a lower-tier fund without regard to the 50% requirements. The 2010 RIC Modernization Act amends the rules regarding the designation of capital gains and other special dividends so that the characterization is made by mailing a statement to the shareholders. The 2010 RIC Modernization Act also eliminates the preferential dividends exclusion for publicly-offered RICs, extends the deadline for declaring and paying spillover dividends and eliminates the penalty for deficiency dividends.

Background
Under pre-2010 RIC Modernization Act law, a RIC’s earnings and profits (E&P) was not reduced by an amount not allowable as a deduction and its current E&P was not reduced by a net capital loss either in the tax year the loss arose or any tax year to which the loss was carried. RICs were subject to special capital loss carryover rules. Losses on RIC stock on which exempt-interest dividends were distributed were disallowed if the stock was held for six months or less. In addition, capitalization of certain load fees paid on RIC stock was required upon the disposition of the stock if the load paid reduced future load charges.

New Law
Under the 2010 RIC Modernization Act, any capital loss treated as arising on the first day of the next tax year is taken into account in determining E&P for the next tax year and disallowed deductions relating to tax-exempt interest income reduce a RIC’s current E&P. If distributions by a fiscal year RIC on a class of stock exceed its current and accumulated E&P, current E&P is allocated first to distributions on the class of stock made during the portion of the RIC’s tax year before January 1^st. The Act provides a safe harbor under which shareholders of a publicly offered RIC will realize capital gains on share redemptions, prevents loss deferral on redemptions of certain lower-tier RIC stock by upper-tier RICs in fund-of-funds structures, allows losses on short-term dispositions of shares on which exempt-interest dividends were paid in the case of RICs that regularly declare and distribute exempt-interest dividends, and limits the application of the continued capitalization requirement of RIC load charges.

Background
An excise tax is imposed on a RIC for a calendar year equal to 4% of the excess (if any) of the required distribution over the distributed amount. Under pre-2010 RIC Modernization Act law, the required distribution was the sum of 98% of the RIC’s ordinary income for the calendar year and 98% of the capital gain net income for the one-year period ending October 31^st of the calendar year. An excise tax is imposed on a RIC for a calendar year equal to 4% of the excess (if any) of the required distribution over the distributed amount. Under pre-2010 RIC Modernization Act law, the required distribution was the sum of 98% of the RIC’s ordinary income for the calendar year and 98% of the capital gain net income for the one-year period ending October 31^st of the calendar year. The distributed amount was the sum of the deduction for dividends paid during the calendar year and the amount of the RIC’s taxable income or net capital gains on which corporate income tax was imposed for tax years ending during the calendar year. Because the treatment of a distribution as a dividend and the character of the dividend depend on the amount and the character of the RIC’s income, special rules applied to certain gain recognized after October 31^st. Under pre-2010 RIC Modernization Act law, the excise tax did not apply to a RIC for any calendar year if at all times during the calendar year each shareholder in the RIC was either a tax-exempt qualified pension plan or a segregated asset account of a life insurance company held in connection with variable contracts.

New Law
The 2010 RIC Modernization Act increases the percentage of pre-October 31^st capital gains included in the required distribution amount to 98.2% and provides for the inclusion of amounts for which estimated tax was paid during the calendar year in the distributed amount. The 2010 RIC Modernization Act allows RICs to elect to defer late-year losses for RIC income tax purposes and provides for the deferral of specified losses for RIC excise tax purposes. The 2010 RIC Modernization Act also expands the definition of shareholders eligible for the RIC excise tax exemption to include additional tax-exempt entities and other RICs.

Tax Refunds Received in 2010, 2011, or 2012 Will Not Affect Eligibility for Federal Benefit Programs

Certain refundable tax credits are disregarded in determining eligibility for benefits or assistance under federal programs. However, under pre-2010 Tax Relief Act law, the treatment of those credits was not uniform.

The making work pay credit is not considered a resource for purposes of determining eligibility for federal or federally-assisted programs for the month of receipt and the following two months.

The child tax credit is not considered a resource for the month of receipt and the following month. The earned income credit has a rule similar to the child tax credit, but only for the programs listed in Code Sec. 32(I).

Under the 2010 Tax Relief Act, any refund or advance payment of a refundable credit made to an individual under the Internal Revenue Code is not taken into account as income, and is not taken into account as resources for a period of 12 months from receipt, in determining the eligibility of the recipient or any other individual for benefits or assistance, or the amount or extent of benefits or assistance, under any federal program or any state or local program financed in whole or part with federal funds. This rule overrides any other provision of law.

Thus, the receipt of a tax refund or advance payment of a refundable credit begins a 12-month period during which the refund may not be taken into account as a resource in determining eligibility for federal or federally-assisted programs.

This rule will not apply to amounts received after December 31, 2012.