Analyzing the Tax Cut Deal

President Obama signed a tax bill into law yesterday (Friday) that gives us some clarity on what the tax situation will be for 2011 and 2012.  Here are the highlights of the bill:

• Tax brackets to remain the same, with a 10% bottom rate and a 35% top rate.  Without this legislation, the bottom rate would have increased to 15% and the top rate to 39.6%.
• A "payroll tax holiday" that reduces the amount of FICA withholding by 2% (self-employed taxpayers will see their self-employment tax decrease by 2%).  For a person making $40,000/year, this would equal an $800 savings.  (But the Making Work Pay Credit is expiring, which negates some of the savings.)
• Another "patch" to the Alternative Minimum Tax that will help millions of taxpayers avoid this tax.
• The capital gains and qualified dividends rates remain at 0% for taxpayers in the 10% and 15% tax brackets, and at 15% for taxpayers in the higher tax brackets. 
• The Child Tax Credit will remain at $1,000 (it had been set to decrease to $500 in 2011).
• You can claim dependent care expenses of $3,000 for one child or $6,000 for two or more children.  These amounts had been set to decrease to $2,400 and $4,800.
• The expanded Earned Income Credit remains in place through 2012.
• The credit available for energy efficient upgrades to your home remains in place through 2012 (it had been set to expire at the end of this year).
• Extension of the American Opportunity Credit for college expenses, and an extension of the "above-the-line" deduction for college expenses.
• Special 100% "bonus depreciation" for purchases of brand-new assets from September 9, 2010, through the end of 2011.
• The estate tax returns with a $5 million exemption per person, and a 35% top rate, retroactive to January 1, 2010.  Estates arising in 2010 will have the option of of using these rules, or using the "old rules" of no estate tax and a reduction in the amount of increase in carryover basis.

Deal Reached on Taxes (Maybe)

President Obama and Republicans in Congress have reached an agreement on taxes.  The agreement calls for the following:

• Extension of the Bush Tax Cuts through the end of 2012.  For more on what this means, see this article posted a few days ago on the Dinesen Tax Times.
• A two-year "AMT patch."  This will prevent an estimated 22 million taxpayers from falling victim to this tax.  For more on what would happen without this patch, see this Dinesen Tax Times article.
• Extension of the expanded Earned Income Tax Credit, extension of the expanded child tax credit, and extension of the American Opportunity Credit for college expenses.
• Extension of miscellaneous tax provisions such as the additional standard deduction for real estate taxes paid by non-itemizers.  The $250 "above-the-line" deduction for classroom expenses of K-12 teachers is also extended.
• Unlimited expensing of new assets in 2011.
• A reduction in the employee portion of FICA withholding, from the current 6.2% to 4.2%.  For a person making 40,000 per year, this would equate to a savings of $800 over one year.  This provision may have been put in the agreement to make up for the expiration of the Making Work Pay Credit.
• The estate tax will return with a $5 million exemption and a top rate of 35%

Democrats are not happy with this proposal, so it remains to be seen if it will actually be passed into law.

Making Work Pay Credit Expires - Paychecks Will Decrease

I haven't seen much media coverage of the "Making Work Pay Credit," but this credit expires soon and will cause a lot of people's paychecks to be smaller in 2011.

The Making Work Pay Credit was part of the 2009 economic "stimulus" package and existed in 2009 and 2010, but is set to expire on December 31st.

The credit amounts to $400 per person for most working adults.  People who receive W-2 wages have received the credit bit-by-bit in each paycheck, in the form of lower withholding. 

If Congress does not renew the Making Work Pay Credit, you'll notice that your first paycheck of 2011 will be lower.  The decrease will amount to $33.33 per month per person ($400/12).

President Obama has proposed extending the credit into 2011, but lawmakers have not been receptive to the idea.

(UPDATE:  the tax bill signed into law December 17th, 2010, did not extend the Making Work Pay Credit, but it did provide for a reduction in FICA withholding from paychecks in 2011, which will more than offset the expiration Making Work Pay Credit.)