The new tax law adds some new tax breaks while extending others

New perk makes estate planning easier for couples

December 26, 2010|By Eileen Ambrose, The Baltimore Sun

While much attention has been paid to the extension of Bush-era tax cuts in the massive tax package signed by President Barack Obama this month, Congress also tucked in other tax breaks and tweaks.

And not everyone will benefit.

The bill cuts the payroll tax so workers will get more in their paychecks next year, although some workers will see a bigger bump than others — and some won't get any.

The home improvement energy credit returns, but it's stingier. Meanwhile, the federal estate tax is resurrected in a far more generous form. And a new feature was added to ease estate planning for married couples.

Here's the bottom line on some of the coming tax changes:

Payroll Tax Relief For next year only, the payroll tax taken out of your check for Social Security will be reduced by 2 percentage points.

You'll see 4.2 percent — instead of 6.2 percent — of the first $106,800 of earnings going to Social Security. This will put an extra $2,136 in the paychecks of the highest earners.

"It's a way to get money into the hands of a lot of people," says Mark Luscombe, principal tax analyst with CCH, an Illinois provider of tax information.

But this tax break is skewed in favor of higher-income folks, says Roberton Williams, a senior fellow at the Tax Policy Center in Washington. In fact, low-income workers could end up paying more in taxes next year than this year.

That's because this tax cut replaces the Making Work Pay Credit, which reduced tax withholdings for two years so that workers got up to $400 more in their paychecks annually, and up to $800 if they're married. That means singles earning less than $20,000 and couples making under $40,000 will receive less from the payroll tax cut than they do from Making Work Pay, according to Williams.

People earning more than that, though, are better off with the payroll tax cut. For example, a couple earning $250,000 next year would get a payroll tax cut worth $4,272. They got nothing this year from Making Work Pay because they made too much to qualify.

But if low-income workers feel a bit cheated, they won't be the only ones.

About 6 million people, made up of longtime federal employees and some state and local government workers, won't get any payroll tax relief because they don't participate in Social Security, Williams says.

Estate tax returns Members of Congress could not agree a year ago on how many millions of dollars the affluent should be able to shelter from the estate tax, so they let it lapse temporarily. Meanwhile, the estates of several billionaires who died this year, including New York Yankees owner George Steinbrenner, escaped taxes.

But with the estate tax set to return in 2011 with terms far less generous than before, a deal was worked out.

For the next two years, an individual will be able to exempt up to $5 million from the federal estate tax, with married couples able to shelter up to $10 million. The maximum tax rate on estates above that will be 35 percent.

Congress also added a new feature to make estate planning easier for married couples.

Traditionally, spouses have set up trusts and titled assets in a certain way to take full advantage of each partner's exemption from federal estate taxes, says Kenneth Aneckstein, a Baltimore estate planning lawyer. But the new law eliminates this hassle.

It does so by making the exemption "portable" between spouses after one dies. So if a husband dies next year without fully using his $5 million exemption, the unused portion can be transferred to his wife and used at her death along with her own exemption.

"It will be helpful for people," Aneckstein says. And even though this and other estate tax provisions expire at the end of 2012, he predicts portable exemption will become a permanent fixture.

But estate planning lawyer Michael Davis in Columbia sees one drawback: Couples might think they no longer have to do any planning.

"There's the Maryland estate tax out there. It's not affected by anything in Washington," he warns. Without proper planning, he says, estates could end up paying more in state taxes than necessary.

Choose your tax Congress also added another twist to the estate tax. If a person died this year, the estate can choose whether to follow the law for 2010 or 2011.

You might think all would opt for this year's law, when there is no estate tax. But for some heirs, next year's law could be more attractive.

Traditionally, if you inherited appreciated stocks or other assets, the cost basis would be stepped up to the fair market at the time of the deceased's death. This reduces or eliminates any capital gains taxes later when you sell the inheritance.

But for this year only, there's a cap on the amount of assets entitled to a step-up in basis. As an heir, you could end up having to pay capital gains taxes based on the original purchase price of the assets when selling them. And that could be steep.

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