Summary of Key Tax Changes: January 2011

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Here is a summary of the changes that will affect small businesses. Remember: to the extent Congress addresses one or more of these issues, the changes outlined below won’t take place. This is not intended to be an all encompassing list and is just a highlight of many things that will be enacted. If you wish to assess how this will affect your personal situation, you should consult a professional that can help you with Tax Planning.

Changes With Income Tax Credits – Generally, a tax credit is a direct reduction in tax liabilities, and is usually put into place in order to encourage a certain behavior. Sometimes tax credits can even result in a refund. This is different from a tax deduction which only lowers your taxable income. Below are a few tax credit changes we will see in 2011 and a few weird ones that already went into effect:

• Child Tax Credit Reduced – In 2011, the child tax credit will be cut in half to $500 per child and may not even be applicable to all taxpayers. For those filing  jointly, the tax credit begins to phase out at $110,000 (AGI) and for taxpayers completing a single tax return at $75,000. While President Obama has mentioned the possibility of increasing this tax credit for families that fall under the middle class, no action has thus far been taken.

• Making Work Pay Tax Credit Gone – This year workers are able to get a tax credit for 6.2% of their earned income with a maximum credit of $400 for single filers and $800 for married couples. In 2011, this tax credit will be eliminated unless Congress acts as Obama’s proposal seeks to extend this credit in 2011.

• Earned Income Tax Credit Reduced for Some – This is a tax credit for low income working families with earned income less than or equal to $48,362. The income limits on this credit vary by your filing status and by the number of children you claim as dependents. In 2011, the EITC is expected to decrease for families with three or more children with higher income phase outs eliminated.

• Hope Tax Credit Changed – This tax credit goes back to being only applicable for the first 2 years of college and the limit goes from being $2500 to $1800. Of course there are income limits as well with this credit. The President has stated he wants to make the changes with this tax credit in 2010 permanent but nothing is set in stone yet.

• Energy-Saving Credits Gone – The current 2010 credit for principal residence homes making changes to housing insulation, windows, doors, HVAC equipment, water heaters and more will expire next year. This tax credit allowed up to 30% ($1.5k max limit) back with applicable energy efficiency improvements.

• HomeBuyer Tax Credit for Veterans – If you or your spouse are part of the  Armed Forces, Military Intelligence or Foreign service and have been engaged in activity duty for at least 90 days outside of the United States you have until April, 30th, 2011 to sign a real estate contract and close by at least June 30th, 2011. Be sure to make note of this date if you intend on purchasing a house and claiming this credit.

Changes With Income Tax Rates and Other Taxes – Tax rates refer to the percentage of taxes that need to be paid with regards to income tax rates, estate transfers, and capital gains.

• Estate Tax To Increase – The Estate Tax, also referred to as the Death Tax, a term that may hold more meaning to many taxpayers, is set to return. Through the Economic Growth and Tax Relief Reconciliation Act in 2001, the estate tax has been phased out over the past 10 years but will unfortunately reach an end this year. This means that unless Congress has a dramatic change of heart, the estate tax will not only return but is set to increase to 55% for homes valued over $1,000,000 dollars (under Obama plan this tax rate is 45%). Therefore, 2010 becomes the year to die!

• Capital Dividends and Gains Hikes – Those who fall within the upper tax brackets should prepare themselves for a changing rate. After this year, the current 15% long-term capital gains rate will return to 20%. However, those in the upper tax brackets will not bear the weight alone as most brackets will be affected. Under former President Bush, the lower 15% income tax bracket had a 0% capital gains rate but this number is expected to rise to 10% in 2011. For the upcoming year, dividends, excluding mutual fund capital gain distributions, will no longer be taxed at 15% for those in the upper tax brackets but will instead is set to be taxed as income. While President Obama is proposing that the dividend rate mentioned here simply be increased to 20% no action has been taken. Regardless of the outcome, those in the upper tax brackets will be faced with a higher tax on dividends.

• Income Tax Hikes – President Obama’s proposed budget for 2011 will extend changes to not only income tax rates but income brackets as well. However, tax breaks for single taxpayers with an income of less than $200,000 and married couples earning less than $250,000 will be exempt from any changes (under his plan). As far as brackets are concerned, the 28% tax bracket is predicted to rise. The 33% tax bracket is also forecasted to increase to 36%. Similarly the top 35% tax bracket is expected to be 39.6% by next year. More importantly, our government is expected to go back to discouraging marriage and the family as the well known “Marriage Penalty” will return with narrower tax brackets and the fact that the standard deduction will not be doubling for married couples what it is for single filers (those slated to get married this year or next will be discouraged to do so, if only marginally).

Changes With Tax Deductions – A tax deduction is not a tax credit. Instead, a tax deduction lowers a taxpayer’s gross income or tax base in exchange for a certain behavior or action. Therefore, it normally reduces indirectly by lowering the amount the taxpayer pays.

• Mortgage Insurance Premium Deduction Gone – Beginning January 1, 2011, taxpayers will no longer be allowed to deduct mortgage insurance premiums from their tax returns. Previously, homeowners who were paying insurance premiums for mortgage contracts that were signed after December 31, 2006 were able to take this deduction assuming they fell within the income cap of $100,000 for families.

• 179 Business Expense Deduction Lowered – For 2011 there are several business taxes that will be affected. The section 179 expense deduction that pertains to small companies and firms emerges as a prime example. Here, the maximum expenses deduction will see a significant decrease from $250,000. Of course, as with all tax deductions, other limitations apply.

• Student Loan Interest Deduction Limit Changes – For 2011, individuals or married couples can only deduct interest from the first 60 months of the repayment term. Moreover, the phase out income limits for claiming the deduction for both single filers and married couples will come down.

Sales Tax & Other Tax Increases That May Affect You:

• Tanning Tax – This tax is an excise or sales tax for those individuals who love to brown their skin. This tax will continue next year and it just started at the beginning of this month. Although it is a mid-year 2010 tax, it is still a new tax that will primarily impact individuals at the end of this year/start of next year as fall and winter approach.

• Brand Name Pharmaceutical Tax – This tax is an annual tax assessment on brand name pharmaceutical companies which amounts to a total of $2.5 billion for 2011. The end result is that many of us will see our brand name drug costs going higher.

Other Notable Tax Changes:

• Coverdell ESA and 529 Plan Alterations – Previously, under a 529 Plan, taxpayers with children were encouraged to invest after-tax money into an account that increased with tax free withdrawals assuming the money was being used to contribute towards educational plans. However, in 2011, 529 Plan withdrawals will not be tax free when paying for the cost of computers or internet access. Coverdell ESA Plan will see changes as well. This plan is similar to the 529 Plan but is directed towards elementary and secondary educational costs. In 2011, the maximum contribution limit per year on this plan will drop dramatically from $2,000 to $500 unless Congress moves quickly.

• HSAs, HRAs, and FSAs Cannot Be Used for Over The Counter Medicine – Americans will no longer be able to use Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs) and Health Reimbursement Accounts (HRAs) to purchase over the counter medicine if it is not insulin. • Economic Substance Doctrine – This sounds confusing but basically is a new IRS provision that gives the IRS more power. If the Internal Revenue Service deems perfectly legal tax deductions as not having “economic substance” because the underlying transactions were enacted to avoid taxes, your business could face penalties.

This information is meant to be general in nature and should not be construed as financial, legal or tax advice related to your personal situation. Contact our office if you need help navigating these confusing tax proposals.

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