Year-End Tax Guide For 2011 - Part 1

Planning makes perfect

Success isn't easy and it certainly isn't free. As your income increases, so does your tax burden. For successful individuals, tax rules become complicated quickly. Whether you're managing your individual tax rates, the rates on your investments, the taxes on your privately held or pass-through business, or the income of executives and shareholders at your company, managing a tax burden has never been more difficult.

That's where tax planning comes in. With so much at stake, don't bury your head in the sand and wait for a big surprise on April 15. There are now more ways than ever to reduce your tax liability, but all of them take planning. Both the tax code and your economic situation are continually evolving. You need to think farther ahead, employ clearer strategies and use every tax break you can. Don't act first and think about taxes later. A little foresight can go a long way.

To help answer as many of your questions as possible, this Grant Thornton guide discusses recent tax law changes and provides an overview of strategies to deal with your situation.

The guide includes information on the following:

Tax law changes: We've dedicated a section to cover the most important tax changes for you and your business. Plus, look for our highlighted Tax law change alerts throughout each section of the guide. Action opportunities: We've highlighted our top 20 Action opportunities. These are strategies you can put into play right now. Business solutions: We know you don't look at your tax situation as an individual taxpayer alone, but also as a shareholder, owner, employee or executive. We've added sections throughout the guide that focus on tax opportunities from the Business perspective. As always, our guide will help show you how to tax-efficiently invest for education and retirement and transfer your wealth to loved ones in the most tax-efficient manner possible. However, this guide simply can't cover all possible strategies, and there may be legislative tax changes after this guide goes to print. Our Washington National Tax Office tracks tax legislation as it moves through Congress. Be sure to contact us to find out what strategies will work best for you and what is happening on the legislative front.

Tax law changes: What's new this year?

Congress walked back from the edge of a tax precipice in 2010 and agreed to extend the 2001 and 2003 tax cuts for two years. The scheduled expiration of these tax cuts at the end of 2010 had threatened to increase taxes on virtually every taxpayer in 2011. The compromise legislation passed last December extended the individual income tax cuts in their entirety through the end of 2012. This massive December tax bill also extended alternative minimum tax (AMT) relief and a number of popular temporary tax provisions known as "extenders."

Yet lawmakers weren't content with a simple extension of expiring tax laws — they also made some key changes. The December tax cut package made dramatic changes to transfer tax rules and offered taxpayers new tax incentives, such as 100 percent bonus depreciation and an employee payroll tax holiday. Earlier legislation, the Small Business Jobs Act of 2010, also included many tax incentives that could benefit businesses this year.

So far, Congress has been quieter in 2011. Lawmakers did repeal an onerous expansion of Form 1099 reporting rules early in the year, but as this guide went to print, had not yet enacted any major tax bills. Of course, 2011 is not over. Congress could still consider revenue increases or tax reform as part of a deficit reduction effort, and the president was pushing for a job creation tax package as this guide went to print. Check with Grant Thornton's Washington National Tax Office for the latest information.

2001 and 2003 individual income tax cuts

The biggest development by far was the extension of the 2001 and 2003 tax cuts. These tax cuts include rate cuts across the individual income tax brackets, plus scores of other tax benefits:

The top rate of 15 percent on dividends and capital gains (on most sales and exchanges) The zero rate for capital gains and dividends in the bottom Brackets The top rate on ordinary income of 35 percent The repeal of the phaseouts of the personal exemption and itemized deductions Marriage penalty relief $1,000 child tax credit and its refundability The increased dependent care credit $10,000 adoption credit and $10,000 income exclusion for employer assistance $2,000 contribution limit for Coverdell education savings Accounts The above-the-line deduction for student loan interest The exclusion for employer-provided education assistance When originally enacted in 2001 and 2003, these tax cuts were given sunsets for a variety of policy, political and budget reasons. The sunset dates are now extended through 2012. Without legislation, the tax cuts will now expire in 2013 — at the same time new Medicare taxes enacted in the health care reform legislation are scheduled to take effect. These Medicare taxes will impose an additional 0.9 percent tax on earned income above $200,000 for singles and $250,000 for joint filers, and a 3.8 percent tax on investment income above those thresholds. We're likely to see another legislative battle over the tax cuts in 2012. See Chart 1 for what is scheduled to happen to tax rates under current law.

Extenders and AMT

The popular tax provisions known as "extenders" include over 30 tax provisions that have traditionally been renewed by Congress on a temporary basis. The provisions expired again at the beginning of 2010, but most were retroactively reinstated for all of 2010 and through 2011. They are now scheduled to expire at the end of 2011.

Key individual tax extenders include the following:

Election to deduct state and local sales taxes Above-the-line tuition deduction $250 above-the-line teacher expenses deduction Standard deduction for property taxes for non-itemizers Tax-free charitable distributions from individual retirement Plans Withholding exception for interest-related dividends of regulated investment companies (RICs) Estate tax look-through for RIC stock held by nonresidents Lawmakers also completed an AMT "patch" for 2010 and 2011. The AMT relief increases the exemptions modestly over 2009 levels (see Chart 2).

Estate and gift taxes

No area of the tax code has shifted more dramatically over the last few years than transfer taxes. Under the 2001 and 2003 tax cuts, the estate tax and generation-skipping transfer (GST) tax were temporarily repealed for 2010. This relief was scheduled to be short-lived. Like the individual income tax cuts, all transfer tax relief was scheduled to expire beginning in 2011, with the rules reverting to those in place in 2000.

Instead, the compromise tax bill enacted in late 2010 puts in place a new transfer tax regime for 2010, 2011 and 2012.

In general, the legislation:

reunifies the gift and estate tax; increases the gift, estate and GST tax exemption amounts to $5 million; provides for a top gift, estate and GST tax rate of 35 percent; and allows portability between spouses of their estate tax exemption amounts. Although the estate tax and GST tax were nominally reinstated for 2010 under the legislation, the GST tax rate in 2010 is zero and estates of 2010 decedents can elect out of the estate tax if desired. In 2013, transfer taxes are once again scheduled to revert to the rules in place in 2000 — though legislative intervention is likely. See Chart 3 for the shifting transfer tax rules. The drastic swings in transfer tax rules and rates present challenges and opportunities for estate planning. You will likely need to review your estate plan to make sure it still makes sense given the changes in tax law (and your own circumstances). See Chapter 10 for a full discussion of estate planning issues.

Payroll tax holiday

The December tax cut compromise reduced the employee share of Social Security taxes under the Federal Insurance Contributions Act (FICA) from 6.2 percent to 4.2 percent in 2011. Social Security tax is imposed on wages up to an annually adjusted cap that reached $106,800 in 2011, meaning taxpayers at or above the wage cap received a $2,136 tax cut from this provision.

The reduction in FICA taxes also applies to the selfemployment tax, reducing the combined rate from 15.3 percent to 13.3 percent for self-employment income earned in 2011. Consistent with the concept that this reduction comes from the employee's share of employment taxes, this will not reduce the amount of self-employment taxes allowed as an above-the-line income tax deduction, which will continue to be calculated as one-half of 15.3 percent of self-employment income.

New tax opportunities for business

It was another stormy economic year for many businesses, but on the tax front, it was mostly sunshine. Lawmakers again looked to the tax code to try and add fuel to the slow-burning economic recovery. The legislative efforts included not just extensions of current benefits, but many new tax provisions.

Business extenders

Congress last year gave businesses a two-year extension, through 2011, of the popular business tax provisions known as "extenders." These provisions are now scheduled to expire at the end of the year. These "extender" provisions include the following:

Research credit 15-year cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements New markets tax credit Subpart F exception for active financing income Look-through treatment for payments between related controlled foreign corporations under foreign personal holding company income rules Form 1099 reporting

Lawmakers gave businesses a break this year by repealing a drastic expansion of information reporting that would have forced businesses to issue millions of additional Form 1099 information reports beginning in 2012.

Trades and businesses are generally required...