On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the "2010 Tax Relief Act"). The 2010 Tax Relief Act extends many of the Bush-era tax cuts, reduces the employee portion of the FICA tax for 2011, and modifies the estate tax provisions of the Internal Revenue Code of 1986, as amended (the "Code"). This Tax Alert provides a summary of certain key provisions of the 2010 Tax Relief Act.

Temporary Extension of Tax Relief

Individual Tax Rates - Prior to the 2010 Tax Relief Act, the individual income tax rates of 10%, 15%, 25%, 28%, 33%, and 35% (the "EGTRRA Rates") were set to expire at the end of 2010; beginning in 2011, the pre-EGTRRA individual income tax rates of 15%, 28%, 31%, 36%, and 39.6% were to be reinstated. The 2010 Tax Relief Act extends the EGTRRA Rates for two years, through December 31, 2012.

Dividends and Capital Gains - For 2010, both long-term capital gains and qualified dividends are taxed at a maximum rate of 15% (0% for taxpayers in the 10% and 15% tax brackets). Absent the 2010 Tax Relief Act, beginning in 2011 the maximum rate applicable to long-term capital gains would have increased to 20%, and the maximum rate applicable to qualified dividends would have risen to the tax rate imposed on ordinary income (which, absent the 2010 Tax Relief Act, would have been 39.6%). The 2010 Tax Relief Act extends the 0% and 15% rates on long-term capital gains and qualified dividends for two years, through December 31, 2012.

Itemized Deduction Limitation - Prior to 2010, certain high-income taxpayers were required to reduce their itemized deductions by 3% of their adjusted gross income over an inflation-adjusted figure (or by 80% of their itemized deductions, if less). This limitation does not apply in 2010, but was scheduled to become effective again beginning in 2011. Under the 2010 Tax Relief Act, this overall limitation on itemized deductions does not apply for two additional years, through December 31, 2012.

Personal Exemption Phase-out - Prior to 2010, taxpayers with incomes over certain levels were subject to a phase-out of personal exemptions when their adjusted gross income exceeded an inflation-adjusted figure. While this limitation, like the itemized deduction limitation discussed above, does not apply in 2010, it was scheduled to become effective again beginning in 2011. Under the 2010 Tax Relief Act, the personal exemption phase-out does not apply for two additional years, through December 31, 2012.

Temporary Extension of Investment Incentives

Bonus Depreciation - Taxpayers that placed qualified property in service during 2008, 2009, or 2010 were permitted to take an additional first-year depreciation deduction for certain qualified property equal to 50% of the adjusted basis of such qualified property. The 2010 Tax Relief Act extends and expands this bonus depreciation by (i) permitting taxpayers that place qualified property in service after September 8, 2010 and before January 1, 2012 generally to take an additional first-year depreciation deduction equal to 100% of the cost of such property and (ii) permitting taxpayers that place qualified property in service after December 31, 2011 and before January 1, 2013 generally to take an additional first-year depreciation deduction equal to 50% of the cost of such property.

Section 179 Expensing - Prior to the 2010 Tax Relief Act, for taxable years 2010 and 2011, taxpayers that invest in certain qualifying property may elect under Section 179 of the Code to expense (i.e., deduct) the cost of such property, rather than recovering such cost through depreciation. The maximum amount permitted to be expensed in 2010 and 2011 is $500,000 (subject to reduction if the cost of all qualifying property placed in service during the year exceeds $2 million). Absent the 2010 Tax Relief Act, the maximum amount permitted to be expensed in 2012 would have been $25,000 (subject to reduction if the cost of all qualifying property placed in service during the year exceeds $200,000). The 2010 Tax Relief Act permits taxpayers to expense up to $125,000 (subject to reduction if the cost of all qualifying property placed in service exceeds $500,000) of the cost of qualifying property placed in service during 2012. After 2012, the maximum amount permitted to be expensed reverts to $25,000 (subject to reduction if the cost of all qualifying property placed in service during the year exceeds $200,000).

Temporary Extension of Certain Expiring Provisions

Energy Provisions - The Code contains numerous provisions providing credits and other tax incentives for businesses engaged in the energy industry. In addition to the incentives applicable to businesses, several Code sections are aimed at providing relief to energy-conscious individual taxpayers. Many of these expired in 2009 or were set to expire at the end of 2010. The 2010 Tax Relief Act reinstates and/or extends temporarily a number of these energy tax incentives, including:

  • The cash grant program for specified renewable energy property placed in service in 2009 or 2010 (or by a later termination date if construction of the property begins by the end of 2010) in lieu of the production tax credit ("PTC") or the investment tax credit ("ITC"), which is extended for an additional year to include property placed in service on or before December 31, 2011, or by a later termination date if construction of the property begins by the end of 2011. For a more detailed discussion of this provision, see Reed Smith's Tax Alert 2010-281;
  • The credits for biodiesel and renewable diesel fuels (reinstated for 2010 and extended through December 31, 2011);
  • The credit for refined coal facilities (reinstated for 2010 and extended through December 31, 2011, for new refined coal facilities other than refined coal facilities that produce steel industry fuel);
  • The excise tax credits for alternative fuel and alternative fuel mixtures (reinstated for 2010 and extended through December 31, 2011);
  • The credit for alcohol fuels (other than the cellulosic biofuel producer credit) and the excise tax credit and outlay payment provisions for alcohol fuel mixtures (extended for one additional year, through December 31, 2011);
  • The credit for construction of energy-efficient homes (extended for two years; applies to homes sold by an eligible contractor after December 31, 2009 and before January 1, 2012);
  • The credit for eligible production of energy-efficient appliances (extended for one additional year for appliances manufactured in 2011, with modifications to certain limitations in calculating the credit); and
  • The credit for individuals for certain nonbusiness qualified energy-efficient property (extends the credit for one year to property placed in service in 2011, with stricter efficiency standards).

Individual Tax Provisions - The 2010 Tax Relief Act also retroactively reinstates for 2010 and extends through December 31, 2011 certain Code sections aimed at providing relief to individual taxpayers, including:

  • The provision permitting individuals to elect to deduct state and local sales taxes in lieu of state and local income taxes; and
  • The provision permitting tax-free distributions from IRAs to a section 501(c)(3) organization (other than a supporting organization or a donor advised fund) of up to $100,000 per taxpayer per year; in addition, individuals will be allowed to make charitable distributions from their IRAs during January 2011 and treat them as if made during 2010.

Business Tax Provisions - The Code contains a number of sections that provide incentives for businesses engaged in certain activities that expired December 31, 2009. The 2010 Tax Relief Act retroactively reinstated for 2010 and extended through December 31, 2011 several of these incentives, including:

  • The research credit for qualified research expenses;
  • The new markets tax credit for qualified equity investments;
  • The provision permitting the expensing of certain film and television production expenses (applies to productions commencing prior to 2012);
  • The provision permitting the expensing of certain environmental remediation costs;
  • The rules exempting from gross basis tax and from withholding tax the interest-related dividends and short-term capital gain dividends received by a nonresident alien individual from a regulated investment company ("RIC");
  • The provision that includes a RIC in the definition of "qualified investment entity" for purposes of the Foreign Investment in Real Property Tax Act;
  • The provision excluding from U.S. taxation certain active financing income (i.e., in general, income that is derived in the active conduct of a banking, financing or similar business) of controlled foreign corporations ("CFCs");
  • The "look-thru rule" for certain income (i.e., dividends, interest, rents and royalties) between related CFCs, which excludes from U.S. taxation such income received by a CFC from a related CFC; and
  • The provision excluding from both regular tax and alternative minimum tax 100% of the gain on the sale of qualified small business stock purchased on or prior to December 31, 2011 and held for five years. For a more detailed discussion of the provision excluding 100% of the gain on the sale of qualified small business stock, see Reed Smith's Tax Alert 2010-263.

Temporary Employee Payroll Tax Cut

The Federal Insurance Contribution Act imposes a tax (the "FICA Tax") on employees and employers. The rate of the FICA Tax for 2010 is 15.3% (7.65% for the employee portion and 7.65% for the employer portion). As a parallel to the FICA Tax, the Self-Employment Contributions Act imposes a tax on self-employed individuals with respect to their self-employment income (the "SECA Tax"). The rate of the SECA Tax for 2010 is 15.3%. The 2010 Tax Relief Act reduces the employee portion of the FICA Tax by 2 percentage points for 2011 so that the rate of the FICA Tax for 2011 will be 13.3% (5.65% for the employee and 7.65% for the employer). Similarly, the 2010 Tax Relief Act reduces the SECA Tax rate by 2 percentage points for 2011 so that the rate of the SECA Tax for 2011 will also be 13.3%.

Temporary Estate Tax Relief

Prior to the 2010 Tax Relief Act, the estate tax provisions of the Code were to have been repealed for decedents dying in 2010, with the estate tax reinstated at pre-2001 rates and exemption levels for decedents dying after December 31, 2010. The 2010 Tax Relief Act revised these provisions for taxable years 2010, 2011, and 2012. Generally, the 2010 Tax Relief Act provides:

  • For decedents dying in 2010, an election may be made to either (i) pay the estate tax with a $5 million exemption and a 35% maximum rate and receive a fair market value basis in the assets of the estate or (ii) pay no estate tax and receive a carryover basis (subject to certain modifications) in the assets of the estate. The estate is deemed to choose option (i) unless it affirmatively elects option (ii);
  • For decedents dying in 2011 and 2012, the estate tax is reinstated with an exemption amount of $5 million for 2011 (indexed for inflation in 2012) and a top rate of 35%; and
  • For decedents dying after December 31, 2012, the estate tax reverts to a $1 million exemption amount (unified with the gift tax) and a maximum estate tax rate of 55%.

In addition to impacting the estate tax provisions of the Code, the 2010 Tax Relief Act modified the generation skipping transfer tax ("GST") and gift tax provisions of the Code. Highlights of the gift tax changes include:

  • For gifts made in 2010, the lifetime gift tax exemption will remain at $1 million and the gift tax rate will remain at 35%;
  • For gifts made in 2011 and 2012, the lifetime gift tax exemption will be unified with the estate tax exemption into a single $5 million exemption (indexed for inflation in 2012) and a maximum gift tax rate of 35%; and
  • For gifts made in 2013 and later, the gift tax reverts to a $1 million exemption amount (unified with the estate tax) and a maximum gift tax rate of 55%.

For a more detailed explanation of the estate, gift and GST tax changes contained in the 2010 Tax Relief Act, please see the Tax Alert prepared by Reed Smith's Wealth Planning Group, which is available upon request.

The 2010 Tax Relief Act is an extensive piece of legislation and the provisions discussed in this Tax Alert represent only a small number of the changes made to the Code. The discussion herein is intended only to provide a general summary of the 2010 Tax Relief Act. If you have any questions about any of the foregoing or would like to discuss the 2010 Tax Relief Act and how it may impact you or your business, please contact one of the authors or the Reed Smith attorney with whom you regularly work.

To ensure compliance with Treasury Department regulations, we inform you that any federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Code or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.

This article is presented for informational purposes only and is not intended to constitute legal advice.