Reading the Tea Leaves

By: William J. Killory, CPA (Nov, 2010)

The November elections are over with the Republicans winning historic gains and improving their position in the Senate. This will change the political dynamics in the next Congress starting in January. In the meantime, the Democrats are still in charge of both houses until the end of the year and will consider a variety of issues that will affect every taxpayer in the country, rich, poor and middle class.

2010 was a busy year for tax legislation. The HIRE Act passed in March allowed payroll tax relief for new hires and extended the generous expensing deduction for fixed asset purchases under Section 179 to $250,000 with limitations for total purchases over $800,000. The Heath Care and Education Reconciliation Act was signed into law on March 30. While most of the new law will impact us in future years it did create a new credit for small employers that provide health coverage, instituted a 10% excise tax on tanning salons and codified the economic substance doctrine. In early July the homebuyer’s credit was given an extension to allow for properties under contract to close by the end of September.

In late September the President signed the Small Business Jobs Act. This extended the 50% expensing election for new assets placed in service in 2010. It also increased the expensing election to $500,000 from the $250,000 under the HIRE Act passed in March. The phase out for asset purchases was increased to $2,000,000 and was extended to 2011. The holding period for built-in-gains tax for an S Corporation that was formerly a C Corporation was reduced from seven years to five years in 2011. Self employed taxpayers with health insurance will not have that subject to self-employment tax. These benefits come at a cost. Owners of rental properties will be subject to 1099 information return reporting requirements next year. Starting in January 2011, the penalty for filing an information return late increases from $15 to $30 for each return. If the returns are more than 30 days late the penalty goes to $60 and if they are not filed by August 1, the penalty is $100 per return. The calendar year maximum penalty goes from $250,000 to $1,500,000.

With all the new legislation, Congress has failed to act on increasing the Alternative Minimum Tax exemption amount. For 2010 the exemption is $45,000 for married taxpayers, down from $70,950 for 2009. This can add over $6,700 to a married couples' tax bill for this year unless Congress passes what has been their annual patch. Another perennial extender is the Research and Development Credit. This temporary credit was first passed in 1981 and has expired and been extended over a dozen times over the past thirty years. Both of these items have strong bipartisan support and will likely be passed either this year or early next year if Congress gets around to focusing on this issue.

The big issue is what will happen for 2011. The first paycheck in January will see increased withholdings for everyone. The current tax brackets go from 10% to 35%. On January 1st these brackets will start at 15% and go to 39.6%. Capital gains rates will jump from 15% to 20% and taxes on qualified dividends will go from 15% to whatever your marginal rate is up to 39.6%. The estate tax will return in its full glory with a $1,000,000 exemption and a 55% rate.

The Democratic leadership, including President Obama, indicated they would extend the current tax rates for the middle class – defined as people making less than $250,000. The Republican leadership has indicated they want to extend the Bush tax rates for everyone. Senator Schumer would extend the tax cuts to those who make $500,000 to $1,000,000. Is there room for a compromise and what kind of deals or parliamentary maneuvers will take place to move legislation forward? It is likely that a two year deal will be made but no one knows for sure at this juncture. This has made planning very difficult and where one generally defers income into future years you may want to accelerate earnings this year in case a deal is not cut for 2011. We will keep a close eye on what is happening in Washington and will keep you informed as information develops.

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