Uncertainty Around 2010, 2011 Tax Rules Makes Tax Planning Crucial, But Challenging, Says CCH

Unanswered Tax Issues, Proposed Legislation and Expiring Provisions Which Will Affect 2010 Tax Decisions

(RIVERWOODS, ILL., September 15, 2010) – This year may very well go down in the annals of tax planning history as one of the most challenging, according to CCH, a Wolters Kluwer business, a global leading provider of tax, accounting and audit information, software and services (CCHGroup.com). CCH has been analyzing tax laws since 1913.

“There are many issues that lawmakers are still sorting through related to 2010 taxes, including more than 60 provisions that are part of an extenders bill pending in Congress and a proposed small business jobs bill that would also affect taxes for many business owners,” said CCH Principal Federal Tax Analyst Mark Luscombe, CPA, JD, LLM. “Additionally, there are several issues related to tax code changes for 2011 that could affect steps taxpayers should take now.”

According to Luscombe, much of the uncertainty related to 2010 tax planning stems from the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 ( JGTRRA) . These laws made changes to income tax brackets, capital gains taxes, estate taxes and tax-free retirement contributions for a limited time, with many of the provisions expiring in 2011. CCH issued a Special Tax Briefing on the sunsetting provisions early this week. Additionally, a heated mid-term election also is adding to the uncertainty on how these rules will change.

Below, CCH outlines key tax planning questions taxpayers should ask as well as tax legislation and expiring tax breaks that will affect 2010 tax planning. Many of these also were addressed in a recent 2010 Year-end Tax Planning webinar hosted by CCH.

Common Questions Become More Difficult to Answer

Should I accelerate income and defer deductions?

Conventional wisdom has generally been to delay income and accelerate deductions so that the taxpayer can lower their taxable income for the current year. However, that may not be the best choice for 2010 should income tax brackets change for 2011.

The current tax brackets range from 10 to 35 percent based on taxable income. They were put into effect under EGTRRA and accelerated under JGTRRA . However, those rates are set to expire at the end of 2010. Lawmakers are suggesting different proposals for 2011 tax brackets, including:

  • Legislation to retain all the current tax brackets for 2011; or
  • Legislation to retain the bottom four tax brackets, but increase the top two tax brackets – 33 and 35 percent – to 36 and 39.6 percent, respectively. This proposal would affect single filers earning more than $200,000 and married couples earning more than $250,000.

If Congress does nothing, all the tax brackets will revert to the pre-EGTRRA rates, ranging from 15 to 39.6 percent. Even taxpayers in the lower tax brackets could then see tax bracket changes, meaning more of their income would be taxed at a higher rate.

According to Luscombe, it’s likely that changes to the tax brackets will not be addressed until after the fall mid-term elections.

“While not everyone can control the timing of their income, small businesses owners or independent contractors may want to consider accelerating income into 2010 and delaying deductions, depending upon how Congress addresses this,” said Luscombe.

For a look at 2010 tax brackets see http://www.cch.com/press/news/2010taxbrackets.pdf and for top income tax rates see http://www.cch.com/press/news/historicaltopmarginalincometaxrates.pdf.

Should I sell appreciated investments or harvest losses now to offset higher future capital gain taxes?

JGTRRA reduced the capital gains rates. As a result, the current capital gains rates are 0 percent for taxpayers in the 10- and 15-percent income tax brackets and 15 percent for taxpayers in higher tax brackets. However, these capital gains rates are to sunset to the pre-JGTRRA rates in 2011, increasing capital gain rates to 10 and 20 percent, respectively.

JGTRRA also effectively lowered the taxes on qualified dividends by taxing them at capital gains tax levels rather than as ordinary income. However, this provision also is set to sunset after 2010. As a result, dividends would be taxed again at the higher ordinary income tax rates.

However, some lawmakers are suggesting legislation to retain the 0- and 15- percent tax rates for capital gains and dividends, but add a 20-percent rate for higher income earners – namely, single filers earning more than $200,000 and married couples earning more than $250,000.

If Congress does not block the sunset, then affected taxpayers who have investment gains may want to consider taking them in 2010 at the lower capital gains tax rate. Alternatively, those that have losses may want to save them to offset higher future capital gains.

“Tax planning related to investments can get complicated quickly and there are other factors that need to be considered beyond tax consequences,” said Luscombe. “So it’s best to seek professional guidance before making changes.”

For a historical look at capital gains see http://www.cch.com/press/news/historicalcapitalgainsrates.pdf.

Should I do a Roth IRA conversion?

Starting in 2010, taxpayers are allowed to convert funds from their traditional IRAs, 401(k)s or certain other qualified plans to Roth IRAs, regardless of income. While the income restriction is lifted for 2010 onward, taxpayers making a conversion in 2010 have the added bonus of being able to choose between either paying all the income tax on the converted amount in 2010 or splitting the tax bill evenly over 2011 and 2012.

Whether or not it makes sense from a tax perspective depends on a number of factors, according to Luscombe. For example, a conversion could push a taxpayer into a higher tax bracket, which could make splitting the bill evenly over 2011-2012 more appealing. However, if tax rates increase in 2011 or 2012, the higher tax rates apply.

Additionally, taxpayers are generally only advised to consider a Roth IRA conversion if they can pay the taxes using non-retirement assets. Otherwise, they will be subject to a 10-percent penalty for early withdrawal from their retirement account on any amount not rolled over, in addition to the tax, if they are under age 59½.

Should I maximize retirement plan contributions for 2010?

Many of the current limits on retirement plan contributions were enacted as part of EGTRRA, including contribution level adjustments to 401(k), IRA and Roth IRAs as well as the catch-up contribution for people 55 and older. However, the Pension Protection Act of 2006 made these provisions permanent. Therefore, they will not sunset in 2011 as will many of the income- and investment-related provisions of EGTRRA and JGTRRA.

As a result, for 2010, taxpayers can contribute up to $16,500 in pre-tax dollars to 401(k) plans, with a catch-up contribution of $5,500. Taxpayers also can contribute up to $5,000 to an IRA or Roth IRA, with a catch-up contribution of $1,000.

More 2010 retirement contribution detail is available at http://www.cch.com/press/news/2010retirementplans.pdf.

For tax planning purposes for 2010, the idea of maximizing your contribution still holds true in most cases. However, an individual who has only a limited amount to contribute to an IRA for either 2010 or 2011, for example, and fears their tax rates will increase in 2011, may want to wait until early 2011 to make their contribution decision. Taxpayers have until April 15, 2011, to make an IRA contribution for 2010.

“If your income taxes are going to go up in 2011 and you are trying to decide whether to make a deductible IRA contribution for 2010 or 2011, it may be tax advantageous to make the contribution for 2011,” said Luscombe.

Do I need to do estate planning?

Under EGTRRA, the maximum estate tax rate dropped steadily from 55 percent in 2001 to 45 percent in 2009. In addition, during that same period, the amount of property excluded from the estate tax rose from $675,000 to $3.5 million.

For 2010, there has been a full repeal of the estate tax. However, the estate tax is poised to jump back to the pre-EGTRRA rate of at least 55 percent in 2011, plus a 5-percent surcharge on large estates, with an exclusion amount of $1 million.

Proposed changes to the estate tax laws run along party lines, with many Republicans wanting to keep the current full repeal and Democrats wanting to bring it back. The Obama administration is proposing to maintain the 2009 rate of a maximum of 45 percent on estates of $3.5 million or greater.

“Ever since EGTRRA, estate planning has been in flux because of the ongoing changes and uncertainty caused by the 2011 sunset rule,” said Luscombe. “If Congress does act in the next few months, it’s likely only going to be to adopt a short-term fix. If they don’t act and the estate tax applies to people with estates of $1 million or more, many more taxpayers will need to do estate tax planning.”

For a historical look at estate tax rates see http://www.cch.com/press/news/historicalestategifttaxrates.pdf.

Additional Uncertainties for 2010 Tax Planning

Both an extender bill and a small business jobs bill are expected to be taken up by Congress before year-end and will affect individuals’ and small business owners’ 2010 taxes.

  • The American Jobs and Closing Tax Loopholes Bill of 2010 (HR 4213) addresses more than 60 tax provisions that expired at the end of 2009. This includes extension of the state and local sales tax deduction from federal income, the above-the-line deduction for qualified tuition and expenses for higher education, the teacher’s classroom expense deduction, and tax-free distributions from individual retirement plans for charitable purpose.

    While Congress overall is supportive of the extenders bill, there is contention over how to pay for it. A vote by the Senate in June failed to pass the legislation.
  • Small Business Jobs Act of 2010 (HR 5297) is expected to be addressed by the Senate during the fall session. The Senate version of the bill extends through the end of this year a 50-percent first-year bonus depreciation that had expired at the end of 2009 and extends and doubles Section 179 expensing for 2010 and 2011.

Expiring Tax Breaks

Additional, several tax breaks are set to expire at the end of 2010, meaning taxpayers that want to take advantage of them only have a limited time to do so. These include:

  • The American Opportunity Tax Credit, which replaced the Hope Credit and provides a maximum $2,500 credit per student per year for the first four years of post-secondary education tuition and expenses.
  • Several energy credits, including the tax credit for up to 30 percent (up to a $1,500 lifetime maximum) of the cost of certain energy-efficient home improvements, including installation of insulation and energy-efficient exterior windows and doors, heat pumps, furnaces, central air conditioners and water pumps.
  • The tax credit for the purchase of hybrid vehicles. However, because the credit was only allowed on manufacturer’s vehicles up to a certain limit, the credit already is unavailable for Toyota, Lexus, Honda models and some others as well.

However, whether these expiring tax breaks are gone for good remains to be seen.

“There regularly tends to be extender bills as lawmakers look to keep available the tax credits popular among their constituents,” said Luscombe.

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is the leading global provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. Among its market-leading solutions are The ProSystem fx® Suite, CorpSystem®, CCH® IntelliConnect®, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill. Wolters Kluwer (www.wolterskluwer.com) is a market-leading global information services company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands. Its shares are quoted on Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices.

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EDITOR’S NOTE: Media interested in a complimentary copy CD of the CCH 2010 Year-end Tax Planning webinar should contact Leslie Bonacum at 847-267-7153 or mediahelp@cch.com.