Top Ten Tax Changes For 2011

There were two major legislative acts passed in 2010 that changed numerous tax provisions. The Patient Protection and Affordable Care Act (the “Health Care Act”) provided for comprehensive health care reform while containing various tax changes that take place either immediately or are subject to phase in over the next eight years. The Tax Hike Prevention Act of 2010 (the “Tax Act”) not only extended many of the tax cuts that were set to expire at the end of 2010 but also changed social security and estate tax rates.

The following is a brief summary of the major changes that have significant tax and investment implications. If you have any questions about the affect of these tax changes on your personal situation, please contact us at 407-629-6477.

1. Health Insurance Implications. Starting in 2010, insurers cannot deny health coverage to eligible persons because of a pre-existing health condition. Lifetime limits and restrictive annual limits on health care expenses are now prohibited from most plans. In addition, children under the age of 26 may remain on a parent’s health insurance policy regardless of whether they are still in school. Starting in 2014, U. S. Residents who are not eligible for government sponsored coverage such as Medicare or Medicaid are required to maintain minimum health coverage or pay a penalty. This penalty starts at the greater of $95 or 1% of income in 2014 and escalates to the greater of $659 or 2.5% of income in 2016. The Health Care Act also provided for an expansion of Medicaid to all individuals under age 65 with incomes up to 133% of the federal poverty level (about $29,327 for a family of four). Employers with 50 or more full-time employees will be required to offer minimum coverage or else pay a penalty of $167 per employee per month starting in 2014. New state-run insurance exchanges will be created to provide access to health care for the unemployed and self-employed. The Health Care Act represents a massive government expansion into the health care industry.

2. Higher Taxes for Health Care. Starting in 2013, the Medicare payroll tax will increase by an additional 0.9% on all wages above $200,000 for individuals and $250,000 for couples. Currently, wages are subject to a Medicare payroll tax of 2.9% with the employer and employee each paying one-half. This change would increase the employee portion from 1.45% to 2.35%. In addition, starting in 2013, investment income, including dividends, interest, annuities, royalties, rents and capital gains, would be subject to a Medicare tax of 3.8%. This tax on investment income applies above thresholds of $200,000 for individuals and $250,000 for couples. This is a significant change from prior tax law that always treated investment income as non-wage income and consequently not subject to any Medicare tax.

3. Increased Threshold for Medical Deductions. Starting in 2013, the threshold for the itemized medical expense deduction increases from 7.5% to 10% of adjusted gross income. This change also affects the exception to the 10% early withdrawal penalty on IRA distributions for medical expenses for those under age 59 ½. Previously, any such distributions escaped this 10% penalty. In 2013, only those medical expense amounts in excess of the 10% of adjusted gross income threshold will escape this penalty. The increased threshold does not apply to individuals over age 65 (and their spouses) for tax years 2013 through 2017. In addition, distributions from Health Savings Accounts and Medical Savings Accounts that are not used for medical expenses are subject to an increased penalty of 20% starting in 2011. These changes will make it harder to deduct medical expenses.

4. Employer Tax Credits. Starting in 2010 through 2013, employers with less than 25 employees and average annual wages of less than $50,000 may qualify for a tax credit of up to 35% of employer contributions towards employees’ health insurance premiums. This tax credit is maximized for employers who have less than 10 employees with average annual wages of less than $25,000. In 2014 and 2015, eligible employers purchasing health coverage through a state-run insurance exchange may qualify for a credit of up to 50% of their contribution. This credit phases out as employer size and average wages increases and is meant to encourage small businesses to offer health care coverage to their employees.

5. Increased Tax Forms. The Health Care Act requires businesses to generate a substantial number of new tax forms in an effort by the government to track down unreported income. Starting in 2011, any company that processes credit or debit card payments will be required to send their customers and the IRS a new 1099-K form documenting the year’s transactions. This new form is required when a merchant has at least 200 payment transactions a year totaling more than $20,000 and applies to all payment processors such as Paypal or Amazon.com. The goal of these new regulations is clearly to catch income that is going unreported to the IRS in an effort to generate additional tax revenue. In 2012, these requirements become even more voluminous. All business payments or purchases that exceed $600 in a calendar year will need to be accompanied by a 1099 filing to the recipient and the IRS. This provision will require businesses to obtain the taxpayer identification number of the individual or corporation the payment is made to regardless of size at the time of the transaction. These requirements effectively add a tremendous burden and substantial cost on small businesses in an effort by the federal government to collect more tax revenue.

6. Social Security Tax Break. In 2011, employees will get a 2 percentage point break on their payroll tax. Instead of paying 6.2% social security tax on wages up to $106,800, they will only have to pay 4.2%. This results in slightly higher net paychecks due to the reduced tax withholding. This tax break replaces the Making Work Pay Tax Credit of $400 for singles and $800 for couples in 2009 and 2010. Unlike the prior credit which was limited to the first $75,000 of income for individuals or $150,000 for couples, the payroll tax holiday will be available on every dollar paid into Social Security. Consequently, this credit is more valuable than the prior credit for higher income workers.

7. Alternative Minimum Tax (AMT) Partial Relief. The Tax Act also included the annual ritual of increasing the exemption amount for AMT income. This increase protects nearly 20 million tax files from having to pay the so-called wealth tax. For 2010, the exemption amount increased to $47,450 for individuals and $72,450 for couples. For 2011, these exemption amounts will increase to $48,450 and $74,450, respectively. The exemption amounts are the amounts of AMT-taxable income taxpayers can earn before incurring AMT. Even with these increases, taxpayers who were previously subject to AMT will most likely be subject to it again this year.

8. Extension of Lower Income Tax, Dividend and Capital Gain Rates. The Tax Act extended the current federal income tax rates of 10%, 15%, 25%, 28%, 33% and 35% for the next two years. Equally as important, the Tax Act also extended the lower tax rate on long-term capital gains and qualified dividend income through the end of 2012. For taxpayers in the 10% or 15% ordinary income tax bracket, the capital gain and dividend tax rate will continue at 0% for the next two years. For those in ordinary income tax brackets above 15%, this tax rate will stay at 15% through 2012. Extending these lower tax rates is great news for all long-term equity investors. To take advantage of these historically low capital gains and dividend rates, investors need to reevaluate their current investment allocation.

9. Estate Tax Exemptions and Rates. Before the passage of the Tax Act, the estate tax was set to be reinstated in 2011 at an exemption level of $1 million and a top rate of 55%. In a surprise move, the Tax Act raises the exemption level to $5 million and lowers the top rate to 35%. This is a significant increase over prior levels that effectively eliminates estate taxes from well over 99% of all households. The Tax Act also reinstated the step up in basis concept for determining any gain on a subsequent sale of inherited assets. This concept allows a beneficiary to use as their cost basis the value of an inherited asset as of the day it was inherited rather than as of the day the decedent originally bought it. This concept effectively removes the associated capital gain that would apply on inherited assets that have appreciated over time.

10. Extension of Popular Tax Breaks. A number of expiring tax breaks were extended by the Tax Act. Among them, the option to deduct state and local sales tax as an alternative to state income tax is particularly valuable to those residents of states that have no income tax. This extension results in continued tax savings to all Floridians who itemize their deductions. The Tax Act also continued the $1,000 child tax credit (up from $500 before the Bush tax cuts). Educators can continue to deduct their out-of-pocket expenses for classroom supplies up to $250 regardless of whether they itemize their deductions. Another tax break that was extended involved the deduction for qualified tuition and other education related expenses.

The legal and tax information contained herein is merely a summary of our understanding and interpretation of current tax laws as of December 18, 2009 and is not exhaustive. Where indicated, past performance is not a guarantee or indication of future performance. Nelson Investment Planning Services, Inc. offers securities through Nelson Ivest Brokerage Services, Inc., a member of FINRA, MSRB and SIPC.