Two-Year Tax Cut Extension is Here

Largely consistent with the December 6, 2010 announcement of a deal between the White House and the Senate Republicans, late last night, December 16, 2010, Congress adopted tax cut legislation that President Obama is expected to sign today, December 17, 2010. Most importantly, the legislation, the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,” extends the tax cuts enacted in 2001 and 2003 under President Bush.

The new law will comprise a set of one- and two-year extensions of tax cuts including more than $400 billion for a two-year extension of all of the individual income tax rates established in 2001, as well as a $137 billion two-year patch for the alternative minimum tax. The law also will include cuts of $68 billion to set the estate tax levels at a 35 percent rate with a $5 million per-person exemption level.

In addition, the law will include a 13-month extension of unemployment insurance benefits for the long-term unemployed and a 2 percentage point cut in the individual portion of the Social Security payroll tax for 2011, from 6.2% to 4.2%. The employer rate of Social Security tax remains at 6.2%.

Tax Rate Cuts

Critically, the law will allow the maximum capital gains tax rate and dividends rate to remain at 15% in 2011 and 2012. In addition, the highest individual income tax rate will stay at 35% for two more years, rather than rise to 39.6%.

More specifically, the marginal tax rates on the various income brackets would remain at 10%, 15%, 25%, 28%, 33%, and 35% for the next two years, rather than revert to the 2001 rates of 15%, 28%, 31%, 36%, and 39.6%.

The law will provide for a two-year extension of certain marriage penalty relief, the $1,000 child tax credit, and income tax deductions for state and local taxes. A two-year Alternative Minimum Tax patch raises the exemption level from $45,000 for couples to $72,450 in 2010 and $74,450 in 2011, preventing an estimated 20 million additional taxpayers from being affected by the tax. For individuals, the exemption level rises from $33,750 to $47,450 in 2010 and $48,450 in 2011.

The estate tax provisions are probably the most controversial element of the bill, prompting many Democrats in the House to raise last-minute stalling tactics. The new law provides for a 35% estate tax rate for 2011 and 2012, and an exemption level of $5 million per person, or $10 million per married couple. House Democrats had been pushing for a rate of 45%, and an exemption amount of $3.5 million. Without this law, the estate tax rate would have reverted to a pre-2001 level of 55% with an exemption amount of $1 million. For more details, click here to see the related article.

Energy Tax and Other Provisions and Extenders

Several energy-related items will also be included in the new law, including a one-year extension of the grants in lieu of investment tax credits program for renewable energy under Section 1603 of the American Recovery and Reinvestment Act of 2009 (“ARRA”). The production tax credit for ethanol makers continues at 45 cents per gallon through the end of 2011. For more information on the grants in lieu of investment tax credits provision included in the bill, click here to see the related article.

In addition to the foregoing provisions, the legislation includes several extensions of Obama-backed tax provisions from ARRA and additional stimulus measures aimed at boosting economic activity. On the business side, the law will include a new provision giving companies the ability to fully depreciate the cost of any capital expenditures made in 2011, and extends the 15-year straight-line cost recovery provision for improvements made to qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements through the end of 2011.

The law also will extend for two years the popular research and development tax credit and the Subpart F active financing exemption used by multinational firms. Finally, the law will extend the New Markets Tax Credit through 2011, allocating $3.5 billion for the program in 2010 and 2011.

IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.