What’s On The Tax Horizon for 2011?

Numerous tax provisions enacted in 2001 and 2003– often referred to as the “Bush tax cuts”– are set to expire at the end of 2010. There has been talk in D.C. to extend some of these expiring tax provisions with new legislation, but election-year politics make it difficult to predict what action, if any, Congress will take.  As it stands now, here are the major changes scheduled for 2011.

Federal income tax brackets

Right now, there are six income tax brackets: 10%, 15%, 25%, 28%, 33%, and 35%. For 2010, these brackets apply to married couples filing joint federal income tax returns in the following manner. As it stands now, there will be no 10% bracket for 2011, and the remaining bracket rates will return to their original 2001 levels: 15%, 28%, 31%, 36%, and 39.6%.

Tax rates on long-term capital gains and qualified dividends

For 2010, if you sell shares of stock that you’ve held for more than a year, any gain is a long-term capital gain, generally taxed at a maximum rate of 15%. If you’re in the 10% or 15% marginal income tax bracket, however, you’ll pay no federal tax on the long-term gain (a 0% tax rate applies). That means if you’re a married couple filing a joint federal income tax return, and your taxable income is $68,000 or less, you pay no federal tax on the gain.

However, these rates expire at the end of 2010. Beginning in 2011, a 20% rate will generally apply to long-term capital gains. Individuals in the 15% tax bracket (remember, there won’t be a 10% bracket in 2011) will pay the tax at a rate of 10%. Special rules (and slightly lower rates) will apply for qualifying property held for five years or more.

Currently, qualifying dividends are taxed using the same capital gains tax rates described above (i.e., 15% and 0%), but in 2011 they’ll be taxed as ordinary income and subject to the increased 2011 tax brackets.

The estate tax

For 2010, there is no federal estate tax and special rules are in place that govern the way the value of property basis is calculated when it is passed to new owners upon death. However, the estate tax reappears in 2011,  with a $1 million exclusion amount. This means that up to $1 million of assets will be exempt from estate tax, with a top tax rate of 55%. This is the threshold that was in place in 2001. To put that in context, for 2009, the top estate tax rate was 45%, and estates received an exclusion of $3.5 million.

Other important changes for 2011 include:

  • Phaseout of itemized deductions and exemption amounts–Itemized deductions and personal exemption amounts will  again be phased out for higher-income individuals
  • The “marriage penalty” returns--Changes made to correct the federal income tax “marriage penalty” expire at the end of 2010, resulting in a reduced standard deduction amount and lower tax bracket thresholds (i.e., higher rates will apply at lower income levels) for married couples filing jointly in 2011
  • Tax credits get cut–The child tax credit will be reduced and both the Hope education tax credit and the earned income tax credit become less generous (the Making Work Pay tax credit also disappears)
  • Section 179 small business expensing–The increased IRC Section 179 expense limit ends (Section 179 allows small businesses to elect to expense the cost of qualifying property rather than recover the cost through depreciation deductions); the amount that a small business may expense will drop from $250,000 in 2010 to $25,000 in 2011
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