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Archives for December 2010

Brand New 1st Year Expensing & FICA Tax Cut

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This post will explain a couple more of the changes in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  


In this post, I will focus on

  • 100% bonus depreciation for September 8, 2010 through December 31, 2011
  • 50% bonus depreciation for all of 2012
  • The reduction in the employee portion of FICA for Old Age, Survivors, and Disability Insurance
100% and 50% Bonus Depreciation

It seems like only a month ago when I posted the return of 50% bonus depreciation under the Small Business Jobs Act of 2010.  Actually, it was two months ago.  That post can be read here.  Bonus depreciation allows you to deduct the purchase price of certain assets much faster than if you had to follow the normal depreciation schedules. 

The 2010 Tax Relief Act extends and expands additional first year depreciation to equal:
  • 100% of the cost of qualified property placed in service after September 8, 2010 and before January 1, 2012
    • Why such a specific date such as September 8?  Wonder what Congressperson/Senator has a constituent that bought a lot of assets on September 9…
  • 50% of the cost of qualified property placed in service after December 31, 2011 and before January 1, 2013.
Example:  ABC Corp bought $1 million of assets on October 1, 2010.  It can fully deduct the $1 million of asset purchases in 2010.  If it creates a net loss for the business, the loss can be carried back or carried forward.

Only assets that meet the following criteria are eligible for bonus depreciation:
  • It falls into one of the following categories:
    • property with a recovery period of 20 years or less
      • which includes most physical assets other than real estate
    • computer software (generally, off-the-shelf software)
    • qualified leasehold improvement property
  • ITS ORIGINAL USE BEGINS WITH THE TAXPAYER (I.E., IT IS PURCHASED NEW)
Qualified leasehold improvement property means any improvement to an interior portion of a nonresidential building if

  • such improvement is made pursuant to a lease by the lessee, sublessee, or lessor of such improved portion
  • such portion is to be occupied exclusively by the lessee or sublessee
  • such improvement is placed in service more than 3 years after the date the building was first placed in service

Qualified leasehold improvement property does NOT include:

  • an enlargement of a building
  • any elevator or escalator
  • any structural component benefiting a common area
  • the internal structural framework of the building

A lease between related persons (e.g., a lease between a taxpayer and his 80% owned business) does not qualify.


Bonus depreciation will not apply to qualified restaurant or qualified retail improvement property.

FICA Tax Cut

The Federal Insurance Contributions Act (FICA) imposes two taxes that total 7.65%.  The first is a 6.2% tax for Old Age, Survivors, and Disability Insurance (OASDI).  The second is a 1.45% tax for hospital insurance (Medicare).  Under old law, the employer and employee each paid a FICA tax rate of 7.65%.  Self employed people pay both the employer and employee portion of FICA and therefore pay self employment tax of 15.3% (7.65% times 2).  
For compensation received in 2011, the Act reduces the employee OASDI tax rate from 6.2% to 4.2%.  The total FICA taxes paid by employees will be 5.65% (4.2% OASDI plus 1.45% Medicare).  The employer portion of OASDI remains at 6.2%.  The employer continues to pay the current FICA rate of 7.65% on its employees’ wages (6.2% OASDI plus 1.45% Medicare).
The OASDI rate for self employment people is reduced from 12.4% to 10.4%.  The total self employment tax is therefore 13.3% for 2011 (10.4% OASDI plus 2.9% Medicare).  
Under old law, self employed people were able to deduct half of the self employment taxes paid.  The deductible half represented the employer portion of FICA.  Since the employer portion of OASDI is 6.2% and the employee portion is 4.2%, the deductible employer portion of total OASDI is now 59.6% (6.2% divided by total OASDI of 10.4%).  The deduction for the Medicare portion of self employment tax remains at 50%.
Example:  Joan has a proprietorship with $92,350 income subject to self employment tax.  The OASDI portion of self employment tax is $9,604.40 ($92,350 times OASDI tax rate of 10.4%.  The Medicare portion of self employment tax is $2,678.16 ($92,350 times Medicare tax rate of 2.9%).  Joan can deduct 59.6% percent of her OASDI tax of $9,604.40–which is a deduction of $5,724.22.  Joan can deduct 50% of her Medicare tax of $2,678.16–which is a deduction of $

Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Big Changes to the Estate Tax Law

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On December 17, the President signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.  This law prevented the increase in tax rates for all taxpayers, as well as create some new and interesting tax law changes for both individuals and businesses.  This post will focus on the radical changes to the estate tax.
Notable changes to the estate tax include:
  • A $5 million exemption ($10 million for spouses)
    • The estate tax exemption would have been $1 million in 2011
  • A 35% tax rate (down from 45% in 2009)
    • The estate tax rate would have maxed out at 55% in 2011
  • Estate tax exemption portability 
  • For 2010 the choice of either:
    • being subject to the estate tax and receiving a step up in basis
    • not being subject to the estate tax and following the carryover basis rules
A Very Brief History of the Estate Tax
Over the past ten years, Congress had phased the estate tax out of existence.  In 2009, the estate tax exemption amount was $3.5 million dollars and the estate tax rate was 45%.  In 2010, the estate tax was completely abolished; although the gift tax remained with an exemption of $1 million and a 35% tax rate.  When the estate tax is in effect, assets receive a “step up” in basis in the hands of the inheritors.  This means that the basis of assets equals the fair market value at the date of death, and the inheritors can then sell the assets tax free (if sold promptly after death).
Example:  John bought stock for $20,000 in 1960.  John died in 2009 while the value of the stock was $200,000.  John’s son Tim inherits the stock.  If there was no step up in basis, Tim would sell the stock for $200,000 and would have a gain of $180,000 ($200,000 sales price less $20,000 basis).  Since John died while the estate tax was in effect, the stock gets a step up in basis to $200,000. Tim can now sell the stock for $200,000 without a gain ($200,000 sales price less $200,000 basis).  Tim will have gain or loss if he sells the stock over or under $200,000.

In 2010, since there was no estate tax, there was no step up in basis.  The basis of assets in the hands of the inheritors would be equal to the lesser of market value or the original cost (plus improvements) of the assets.  However, even under the carryover basis rules, taxpayers could still step up the basis of assets up to $1.3 million (a surviving spouse could increase the basis of assets by an additional $3 million).
The New Estate Tax

Higher Exemption Amounts and Lower Tax Rate
The current exemption amount is $5 million per taxpayer, and $10 million for a married couple.  A flat tax rate of 35% applies to amounts over these exemptions.
Estate Tax Exemption Portability
This tax change is very substantial.  But first, some background info:  Each taxpayer has a $5 million exemption.  Taxpayers can transfer assets at their deaths to their spouses free of estate tax.  Under old law, transferring assets to a surviving spouse wasted the exemption of the first spouse to die.
Example:  John and Tina are married.  John has a $10 million estate.  Tina is destitute.  When John dies, Tina inherits all of John’s assets.  There is no estate tax because the surviving spouse inherited all the assets.  However, when Tina dies, her estate is $10 million.  Her estate tax exemption is $5 million, which makes her estate subject to estate tax of $1,750,000 ($10 million estate less $5 million exemption = $5 million estate subject to a tax rate of 35%).  Since John bequested all of his assets to his spouse, he never used his own estate tax exemption.

Exemption portability means that the surviving spouse can now utilize the unused estate tax exemption of her deceased spouse.  
Example:  Same as above, except now exemption portability applies.  Tina can still use her own $5 million tax exemption.  Under portability, she can now use her husband’s unused tax exemption of $5 million.  Since her total exemption of $10 million equals her assets at her death, she will have no estate tax.

To use the exemption portability, the first spouse to die must elect to use portability on his/her estate tax return.  An estate tax return must be filed by the first spouse to die to use portability even if the return is not otherwise required to be filed.
To Be (Subject to the Estate) or Not to Be (Subject to the Estate Tax)
For 2010 only, the choice is between:
  • being subject to the estate tax and receiving a step up in basis
  • not being subject to the estate tax and following the carryover basis rules (an election is required for this choice)
Why would someone want to be subject to the estate tax?  For most people it won’t make sense to be subject to the estate tax.  Even under the carryover basis rules, you can increase the basis of your assets up to $1.3 million (up to $3 million for spouses).  Therefore as long as you want to step  up the basis of your assets under $1.3 million or $3 million, it probably doesn’t make sense to be subject to the estate tax.  Where it does make sense is if you want to step up the basis of your assets over these amounts and won’t be subject to the estate tax (or would be subject to very little estate tax).
Example:  Jane has assets of $1.5 million.  Her basis in her assets is $500,000.  Since the potential step up in basis is the difference of $1 million between the market value and basis, and this amount is less than the maximum step up of $1.3 million, Jane can simply step up the basis of her assets by $1 million under the carry over basis rules.

Example 2:  Jane has assets of $4.5 million and a basis in those assets of $1 million.  Here, the potential step up is $3.5 million.  Under the carryover basis rules, the most that Jane could step up the basis of her assets is $1.3 million.  Under these circumstances it makes sense for Jane to be subject to the estate tax (which would be zero because her estate is under the exemption amount of $5 million), and receive a full step up in basis of $3.5 million.

If Jane has an estate over the exemption amount and would be subject to the estate tax, her advisor would have to do some number crunching to see if it is better to pay estate tax and receive a full basis step up, or avoid the estate tax and end up paying higher income taxes on gains from sales of assets that didn’t receive a basis step up.
Other items to take note:
  • The gift tax exemption is increased to $5 million (up from $1 million) and gift tax is at a 35% rate
  • The generation skipping tax (GST) exemption is $5 million.  
  • The GST tax rate in 2010 is 0%, then 35% in 2011 and 2012
  • There are extensions of filing deadlines for those who died before the enactment of these tax law changes
Oh, and by the way, all these tax rules change on January 1, 2013.  
Happy Holidays!
Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.