2010 Tax Changes: How Much More Will You Pay?

Do you think the complex tax laws could get even more complicated? If you answered yes, you are right. 2010 could be the most critical year ever for changing the rules, but next year promises to make 2010 look downright simple.

Congress left Washington to campaign for the election and left some unresolved tax issues for the next congress, maybe even the lame duck congress, to figure out. Obviously, the current tax structure, known as the Bush tax cuts, is set to expire at the end of 2010 because of a sunset provision included in the bill. This leaves a large amount of uncertainty about the best way for business to spend their money. As a result, cash remains on the sidelines.

Additionally, there could be a set of tax breaks from 2009 that might be valid for 2010 if H.R. 4213 becomes law (American Jobs and Closing Tax Loopholes Act), but that would have to be passed by the lame duck congress.

Before the Bush Tax Cuts expire, important tax law changes could dramatically affect your 2010 tax bill:

1. Estate tax and Generation Skipping Transfer Tax

The estate tax is 0% in 2010. However, if the Congress does not take action before the end of the year, the Estate Tax and the Generation Skipping Transfer Tax (GSTT) will change in 2011.

The consensus among estate planners is Congress will extend the current estate laws. This would allow a $3.5 million exemption for estate tax, and GSTT with a 45% estate, and gift tax rate. However, if congress allows the current tax rates to sunset, the tax rates we would go back to pre-Bush Tax Law Changes. The exemption level would be lowered to $1 million, exposing another $2.5 Million to taxation, with a 55% estate tax, GSTT, and gift tax rate. You read that right, the estate tax rate would go from 0% to 55%.

2. Estate Tax Step-up Basis Rules Replaced by Carryover Basis Rules

It is a bit morbid to say, but 2010 may be a better year than 2011 to pass on an estate to your heirs. In 2010, all assets which are part of an estate are subject to capital gains taxes instead of step up on date of ones passing. What does that mean? If assets were acquired over a period of time, such as 40 years, you will be required to and provide a paper trail to determine your cost basis. You may then end up paying capital gains tax on the appreciated value. Please note that each estate may exempt $1.3 million of gains using the carryover basis rule, and an additional $3 million exemption applies to assets inherited from a spouse. Taken together up to $4.3 million of an estate can utilize the step-up basis in 2010.

3. Federal Gift Tax Rate Changes to 35% for 2010 From 45%

The gift tax remains in 2010 for gifts over the lifetime exemption figure of $1 million. The gift tax liability rate is 35% in 2010. If you gift less than $1 million during your lifetime you are not subjected to the tax at all.

4. No Income Limits on Roth IRA Conversions

One significant benefit in 2010 is that anyone can convert a traditional IRA to a Roth IRA and has the option paying the tax penalty resulting from the conversion over a two year period, years 2011 and 2012. Note that income limits still apply that prevents certain high income earners from actively contributing to a Roth IRA. However, you still can make a contribution to a traditional IRA in 2010 and then convert to a Roth IRA.

5. Loss of State and Local Sales Taxes Deduction

Before 2010, small business owners you could choose to deduct state sales tax payments instead of state and local income taxes. Congress let this option expire at the start of this year. However, Sen. Maria Cantwell (D-WA) has been spearheading a provision to extend the state and local sales tax deduction – so we have a chance that this option may return for tax year 2010.

6. Alternative Minimum Tax (AMT) Exemption

The AMT thresholds were changed with the stimulus plan by the Obama administration. The AMT levels are set as follows for tax year 2010:

Single/Head of Household: $33,750
Married Filing Separately: $22,500
Married Filing Jointly: $45,000

7. Business Mileage Deduction Rates

When using personal vehicle for business purpose, the business mileage deduction changed to from $.55 to 50¢ per mile in 2010. This is a big tax increase for businesses with lots of service vehicles.

8. Exclusion of Unemployment Benefits

In 2009, you could exclude up to $2,400 of unemployment benefits from your taxable income. In 2010, there are no tax breaks for unemployment benefits. The government gives it to you in benefits, and then takes part of it back in taxes. The problem for most people is the lack of cash to pay the tax bill since they needed the benefits for daily living.

9. Elimination of Higher Education Tuition Deduction for 2010

Qualifying taxpayers could take an above-the-line deduction for college tuition and expenses in 2009. For those with an AGI of $65,000 or less, or $130,000 for joint filers, you could deduct up to $4,000. With an AGI up to $80,000, or $160,000 for joint filers, the reduction was limit was $2,000. However, there is no such deduction in 2010, which translates into another tax increase in 2010 unless the lame duck congress acts.

Tax increases have been reported on the news as something to worry about in 2011, but 2010 has seen a number of tax increases. These tax laws have wide implications on individuals and the economy as a whole.

If the Bush tax cuts are allowed to expire and tax rates revert back to 2001 levels, nearly every American will pay more taxes one way or another. If H.R. 4213 is passed, it could provide some tax relief and benefits. Either way, 2010 appears to be one of the most critical years in tax law changes!