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New Tax Bill Extends Current Rates, Increases Estate Tax Exemption

December 17, 2010

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On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 into law. The act temporarily extends the Bush-era tax cuts that were set to expire at the end of 2010 and makes significant changes to the federal estate tax rules.

Income Tax Provisions

The act temporarily extends the Bush-era tax cuts, thus maintaining the highest marginal income tax rate of 35 percent for individual taxpayers. Capital gains and qualified dividends will continue to be taxed at a 15 percent rate (and the 0 percent rate on capital gains for individuals in the 10 percent and 15 percent brackets is preserved). Both of these provisions (the marginal tax rates and the capital gains/qualified dividends rate) are extended for two more years and will now expire on December 31, 2012.

The act also provides other significant tax benefits for individuals, including a payroll tax cut of 2 percent in 2011 for employees and self-employed individuals, patching the alternative minimum tax for 2010 and 2011, extending the child tax credit and the dependent care credit through 2012, extending the election to take an itemized deduction for state and local general sales taxes (in lieu of an itemized deduction for state and local income taxes) through 2011, and extending the rule permitting mortgage premiums to be deductible as qualified residence interest through 2011. Among the provisions applicable to businesses are bonus depreciation provisions for property acquired and placed in service after September 8, 2010 and before January 1, 2013 and the retroactive reinstatement and extension through 2011 of the research credit, new markets tax credit, work opportunity tax credit, and a number of other business tax breaks.

Estate Tax Provisions

The act also makes significant changes to the estate, gift, and generation-skipping transfer tax regimes. Effective retroactive to January 1, 2010, the federal estate tax applies only to estates in excess of $5 million, and the generation-skipping transfer tax applies when a person’s total generation-skipping transfers exceed $5 million. Effective January 1, 2011, the gift tax lifetime exemption also increases to $5 million. The maximum tax rate for all three regimes is reduced to 35 percent, down from the maximum 45 percent rate that was in effect in 2009. All of these changes are set to expire in two years, on December 31, 2012. The federal changes do not affect the New York regime, which imposes an estate tax on New York residents whose estates exceed $1 million.

These changes mean that a married couple can now jointly protect up to $10 million of assets from the federal estate tax. The act also makes it easier for couples to fully use their exemption amounts. Under previous law, if the first spouse to die had not set up a properly structured trust, he or she effectively wasted part or all of the estate tax exemption, increasing the tax due on the later death of the second spouse. Now, the exemption is “portable” between spouses; if the first spouse does not use up his or her exemption, the balance can be used by the surviving spouse on his or her later death. This new portability rule is only in effect for decedents dying after January 1, 2011, and before December 31, 2012. Even with the new portability rule, many married individuals should still consider using trusts because the generation-skipping transfer tax exemption is not portable.

The federal estate tax had been repealed for individuals dying in 2010. Now, the act makes the estate tax apply retroactively to decedents who died in 2010, with a significant caveat. Executors of estates of individuals who died in 2010 have a choice to either have the estate tax regime or a carry-over basis regime apply, a choice that could have significant income tax consequences for the beneficiaries of the estate.

For individuals interested in making significant gifts to their grandchildren, the act creates a short window of opportunity to make these gifts without having to pay any generation-skipping transfer tax. So long as the gifts are made before the end of 2010, no generation-skipping transfer tax will be due. These gifts will have gift tax consequences, however, which should be considered before making the gifts.

For more information about the income tax provisions, please contact a member of our Federal/International Tax Practice Group.

For information about the estate tax provisions, please contact a member of our Estates & Trusts Practice Group.