The MDTAXES Network - Monthly Newsletter for January 2011

On December 17^th, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 into law. From a tax perspective, this Act extended the Bush tax cuts for two years through 2012. Let’s look at some of the specific tax changes:

No Change to Tax Rates:

The six tax brackets will remain unchanged through 2012. That means we’ll continue with the 10%, 15%, 25%, 28%, 33% and 35% brackets for two more years. As we discussed in our October 2010 Newsletter, each of these brackets was set to rise by 3% or more.

Congress included a patch to limit the impact of the Alternative Minimum Tax (AMT) through 2011. Each year, Congress struggles to pass a one-year fix to the AMT that keeps millions of taxpayers from paying this secondary tax. A few years back, it was estimated that the number of people paying the AMT would jump six-fold – from 4 million to 23 million if the ATM patch were not extended that year.

The tax rate on long-term capital gains and corporate dividends remains at 15% through 2012. Without an extension of these tax cuts, the tax rate on long-term capital gains would have jumped to 20%, while corporate dividends would have been taxed at your marginal tax bracket.

Let’s Give Credit Where Credit Is Due:

The Bush tax breaks also extended many of the tax credits claimed by working Americans, including:

Child Tax Credit: This credit worth $1,000 per child under the age of 17 would have been cut in half to $500 per eligible child.

Dependent Care Credit: Under the extended rules, you can claim this credit based on the first $3,000 of dependent care expenses paid on behalf of one child, or $6,000 if you have two or more children under the age of 13. Had no extension been passed, this credit would have been cut by 20% - to be based on the first $2,400 of qualified expenses for one child or $4,800 for two or more eligible children.

The new American Opportunity Credit, which was passed by Obama in 2009 and improved upon the Hope Education Credit, was extended through 2012. Originally, this lucrative tax credit would have expired at the end of 2010.

Extended Deductions:

The elimination of the Stealth Tax continues through 2012. For many years, the tax rates for the top tax brackets was higher than advertised due to the fact that taxpayers had their personal exemptions and itemized deductions phased-out once their Adjusted Gross Income exceeded a certain threshold. These phase-outs finally disappeared in 2010, but were set to return on January 1, 2011.

Anyone paying student loans who is eligible to deduct the interest paid will continue to write-off the first $2,500 of interest paid annually. Due to this Tax Act, the rule stating that you can only claim this interest for the first 60 months of repayment will not return until after 2012.

More Depreciation:

This Tax Act makes it a great time to purchase equipment. For starters, purchases of new equipment qualify for unlimited 100% bonus depreciation. That means you can write off the full cost of these assets, no matter how much assets you purchase or how much income you earn. Only new assets purchased between 9/9/10 and 12/31/11 qualify.

If you purchase used equipment, you can still write-off the first $500k that you purchase as a Section 179 deduction. Starting in 2012, the Section 179 deduction falls to $125k per year.

Tax Planning Became a Little Easier

After suffering through 2010 when there was a lot of uncertainty about the upcoming tax rules, we can now say confidently that we know exactly what to expect for 2011 and, to a lesser degree, for 2012.

As a way to stimulate the economy, Congress included a provision in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 that reduces the Social Security taxes you will pay in 2011by two percentage points.

Unless you work for the government or qualify as a "student employee", your employer is generally required to withhold Social Security and Medicare taxes from your salary. The 2010 rate was 6.2% for Social Security taxes and 1.45% for Medicare taxes - for a combined rate of 7.65% for these two taxes.

Your employer then matches the Social Security and Medicare taxes withheld from your pay. On each dollar you earn, therefore, the government receives 15.3 cents. Please note that you also pay federal and (most likely) state income taxes on these earnings.

As we discussed in our November 2010 newsletter, there is an annual limit to your wages and self-employment income subject to Social Security taxes. Since 2009, this limit has held steady at $106,800. While you don't pay Social Security taxes on earnings in excess of this threshold, expect to pay Medicare taxes on every dollar you earn.

Now for this year's tax break. For 2011 only, employers will reduce the Social Security taxes withheld from their employees' pay by 2 percentage points. The 2010 rate of 6.2%, therefore, drops to 4.2% for one year only. This means that anyone earning $50k per year will have an extra $1,000 to save or spend in 2011. People earning $106,800 or more will see their take-home pay increase by $2,136, or $178 per month.

This reduced rate applies to the employee-portion of Social Security only. Employers will continue to submit their matching contributions using the 6.2% rate for Social Security and 1.45% for Medicare. (So I guess the employer's 7.65% payment can no longer technically be referred to as a "matching" contribution.)

Self-employed individuals will see a 2% decrease in their "self-employment tax" rate as well. The pre-2011 rate of 15.3% will drop to 13.3% for 2011 only.

Will the government succeed in stimulating the economy by borrowing an estimated $110 billion to reduce 2011 Social Security taxes by two percentage points? Only time will tell.

When George W. Bush was in office, his team suggested partially privatizing social security. His plan was to provide employees paying into the Social Security system with the option of diverting a percentage of his or her Social Security tax withholdings into a personal investment account.

Unlike your accrued benefit maintained by the Social Security Administration, a privatized social security account would contain investments that actually accumulate in your name. The funds in that account would be available to supplement your retirement income, and then, upon your death, any money remaining would pass to your heirs. Why not take this opportunity to invest 2% of your 2011 gross salary, up to $178 per month, into an IRA, annuity, or savings account?

The IRS announced that the standard mileage rate will increase to 51 cents per business mile driven in 2011. That is a jump of just 2% from the 50 cents allowed in 2010.

When you use your car for business, driving between job sites is deductible. So is driving between your home and a temporary job site, job interviews, and conferences. Commuting between your home and a regular place of business generally isn't tax deductible.

There are two ways for you to calculate your automobile expenses. You can either claim $.50 per business mile driven in 2010 (increasing to $.51 for 2011), or you can base your deduction on the percentage of miles your car is driven for business multiplied by the actual costs incurred during the year. Allowable costs include gas, insurance, repairs, parking at home, and either your lease payments, or if you own your car, a factor for depreciation.

Generally, unless you drive your car relatively few miles each year, with most of those miles being allowable business miles, you're better off basing your deduction on the standard mileage rate.

Taxpayers who are compensated as employees generally will claim their deductible automobile expenses as an unreimbursed employee business expense. These type expenses are reported on a Form 2106 and are deducted as a miscellaneous itemized deduction on the Schedule A. Keep in mind that miscellaneous itemized deductions are only allowable to the extent they exceed 2% of your income, and are not allowable when calculating the Alternative Minimum Tax (AMT).

Those taxpayers compensated as independent contractors will generally claim their allowable automobile expenses directly against their self-employment income on a Schedule C, Profit or Loss from Business.

The use of an automobile in connection with a charitable activity is deductible at a rate of 14 cents per mile for 2010 and 2011 and should be reported with other charitable contributions as an itemized deduction of the Schedule A.

Any mileage driven in connection with a qualified move is deductible at a rate of 16.5 cents per mile in 2010, increasing to 19 cents per mile in 2011, and should be reported on a Form 3903, Moving Expenses.

And don't forget that medical related mileage is also deductible. Medical mileage is allowable at 16.5 cents per mile in 2010, and then jumps to 19 cents per mile in 2011, and should be reported with all other medical expenses on the Schedule A.

MONTHLY TAX NEWSLETTER