Understanding Key Provisions of the Tax Bill Passed by the Senate
On December 6, 2010, President Obama announced an agreement with Senate Republicans that would extend for two years the Bush-era tax rates – including the 15 percent long-term capital gains and qualified dividends rate – and would reintroduce the federal estate tax with higher exemption amounts ($5 million per person, $10 million per couple) and lower rates (a maximum of 35 percent), among other significant changes. Yesterday, December 15, 2010, the Senate approved the plan by a wide margin. The proposal is now before the House of Representatives. Although additional modifications may be made to the proposal before any final vote is had, it is important to note the substantial changes that are at issue and begin planning ahead for ultimate passage.
Following is a list of some of the most significant proposed provisions in the bill:
- Federal Estate Tax. The proposal sets the federal estate tax exemption at $5 million per person and $10 million per couple, and a top tax rate of 35 percent for the estate, gift and generation-skipping transfer taxes. The exemption amount is indexed beginning in 2011. The proposal is to be effective January 1, 2010, but allows an election to choose no estate tax and modified carryover basis for estates arising on or after January 1, 2010 and before January 1, 2011. The proposal sets a $5 million generation-skipping transfer tax exemption and a zero percent rate for the 2010 year.
- Individual Tax Rates. Individual income tax rates, which were scheduled to increase, would continue to be imposed at the lower Bush-era rates of 10, 15, 25, 28, 33 and 35 percent.
- Capital Gains/Dividends. Long-term capital gains and “qualified dividends” would continue to be taxed at a maximum rate of 15 percent. Qualified dividends are dividends paid by U.S. corporations and dividends paid by “qualified foreign corporations” – foreign corporations located in a U.S. possession or in a country with which the United States has a comprehensive income tax treaty that contains an information exchange program, and which the IRS has approved for this purpose (see the list of countries in Notice 2006–101).
- Itemized Deduction Limits. The limitations on the number of deductions high-income earners may take was repealed for 2010, and this repeal would be allowed to stand rather than expiring as originally scheduled.
- Alternative Minimum Tax (AMT). The AMT “patch” is intended to prevent the AMT from encroaching on middle-income taxpayers by providing higher exemption amounts and other targeted relief for 2010 and 2011. Without this patch, which had expired at the end of 2009, an estimated 21 million additional households would be subject to its reach.
- Temporary Reduction in Employee-paid Payroll Taxes. Under current law employees pay a 6.2 percent Social Security tax on all wages earned up to $106,800 (in 2011); self-employed individuals pay a 12.4 percent Social Security self-employment taxes of on all their self-employment income up to the same threshold. The bill provides a payroll/self-employment tax holiday during 2011 of two percentage points. This means employees will pay only 4.2 percent on wages and self-employed individuals will pay only 10.4 percent on self-employment income up to the threshold.
- 100 Percent Bonus Depreciation. Under current law, businesses are allowed to recover the cost of capital expenditures over time, according to a depreciation schedule. Congress allowed businesses, beginning on January 1, 2008 and continuing through December 31, 2009, to take an additional depreciation deduction allowance equal to 50 percent of the cost of the depreciable property placed in service in those years. Under the Small Business Jobs Act of 2010, this temporary increase in the depreciation deduction allowance was extended through December 31, 2010. The current bill extends and temporarily increases this bonus depreciation provision for investments in new business equipment. For investments placed in service after September 8, 2010 and through December 31, 2011, the bill provides for 100 percent bonus depreciation. For investments placed in service after December 31, 2011 and through December 31, 2012, the bill provides for 50 percent bonus depreciation. The provision also allows taxpayers to elect to accelerate some AMT credits in lieu of bonus depreciation for taxable years 2011 and 2012.
- Research Tax Credit. The R&D tax credit expired at the end of 2009. The current tax agreement includes a temporary two-year extension of the credit.
- New Markets Tax Credit. Through the New Markets Tax Credit (NMTC) program, the federal government is able to leverage federal tax credits to encourage significant private investment in businesses in low-income communities. The bill extends for two years (through 2011) the new markets tax credit, permitting a maximum annual amount of qualified equity investments of $3.5 billion each year. This is effective for calendar years beginning after December 31, 2009.
- Tax Benefits for Certain Real Estate Developments. The bill extends for two years (through 2011) the special 15-year cost recovery period for certain leasehold improvements, restaurant buildings and improvements, and retail improvements.
- Treatment of Certain Dividends of Regulated Investment Companies (RICs). The bill extends a provision allowing a RIC, under certain circumstances, to designate all or a portion of a dividend as an “interest-related dividend” by written notice mailed to its shareholders not later than 60 days after the close of its taxable year. In addition, an interest-related dividend received by a foreign person generally is exempt from U.S. gross-basis tax under sections 871(a), 881, 1441 and 1442 of the Code. The proposal extends the treatment of interest-related dividends and short-term capital gain dividends received by a RIC to taxable years of the RIC beginning before January 1, 2012.
- Treatment of RIC Investments as “Qualified Investment Entities” Under FIRPTA. The bill extends the inclusion of a RIC within the definition of a “qualified investment entity” under section 897 of the Tax Code through December 31, 2011.
- Active Financing Exception. The bill extends for two years (through 2011) the active financing exception from Subpart F of the tax code.
- Look-through Treatment of Payments Between Related Controlled Foreign Corporations. The bill extends for two years (through 2011) the current law look-through treatment of payments between related controlled foreign corporations under Section 954(c)(6).
- Extension of Special Rule for S Corporations Making Charitable Contributions of Property. The bill extends for two years (through 2011) the provision allowing S corporation shareholders to take into account their pro rata share of charitable deductions even if such deductions would exceed such shareholder’s adjusted basis in the S corporation.
- Exclusion of Small Business Capital Gains. Generally, non-corporate taxpayers may exclude 50 percent of the gain from the sale of certain small business stock acquired at original issue and held for more than five years. For stock acquired after February 17, 2009 and on or before September 27, 2010, the exclusion is increased to 75 percent. For stock acquired after September 27, 2010 and before January 1, 2011, the exclusion is 100 percent and the AMT preference item attributable for the sale is eliminated. The provision extends the 100 percent exclusion of the gain from the sale of qualifying small business stock that is acquired before January 1, 2012 and held for more than five years.
We will closely monitor the bill’s progress and will continue to provide our clients with updates as they occur. Please contact your Holland & Knight attorney with any questions you may have relating to the potential impact of these proposals on you and your business.
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