Prentice Hall’s Federal Taxation
2011 Edition
Tax Legislative Update
Introduction
The year 2010 has been significant for new tax legislation although much of it occurred in the final weeks
of the year. Both Congress and the White House had been under considerable pressure to enact changes
designed to keep the income tax law functioning properly as well as changes deemed important for
economic and political reasons. First, Congress enacted the Small Business Jobs Act of 2010 (SBJA
2010) on September 27, 2010. This Act made some important changes that primarily affected businesses.
More substantive changes, however, came later in a couple of tax bills that we refer to as the Tax Relief
Act of 2010 (TRA 2010). Interestingly, many TRA 2010 changes do not actually change current law but
merely extend current law for two years. Thus, many of the provisions discussed below may not look
different from the textbook because they are essentially the same. Nevertheless, these extensions into
2011 and 2012 are important because, had the extensions not been made, individual tax rates would have
risen and a number of deductions and credits would have expired.
This update covers three basic areas; individual taxpayers, business taxpayers, and estates and gifts. The
chapter in the text that covers a specific item is referenced in bold print at the end of the relevant
discussion.
Summary of Important New Legislation
INDIVIDUAL TAXPAYERS
Individual Tax Rates
Through a phenomenon called “sunset provisions,” whereby a tax law expires upon reaching a specific
date, individual income tax rates were set to automatically increase on January 1, 2011. While the entire
rate structure was scheduled to increase, the most notable increases were the 10% rate increasing to 15%
and the 35% rate increasing to 39.6%. Due to the slow U.S. economy and for political reasons,
policymakers deemed an increase in tax rates at this time as unacceptable, and Congress finally agreed to
extend the 2010 rates of 10%, 15%, 25%, 28%, 33%, and 35% to 2011 and 2012. The thresholds (or
bracket cutoffs), however, will not be exactly the same in 2011 as in 2010 because the brackets are
adjusted for inflation. The appendix to this update reproduces the projected 2011 rate schedules for
individuals (and estates and trusts). Chapter I:2.
Long-Term Capital Gains and Qualified Dividends
Since 2003, qualified dividends and most long-term capital gains (LTCG) have been taxed at a maximum
15% rate. The exceptions are LTCGs subject to either 28% (collectibles or Sec. 1202 stock) or 25%
(unrecaptured Sec. 1250 gain). Also, for the last couple of years, if a taxpayer was in the 15% or lower
individual tax bracket, any LTCG or qualified dividend was subject to a zero tax rate. Both the maximum
15% rate and the zero rate would have increased significantly as of January 1, 2011. TRA 2010 extends
both of these provisions for 2011 and 2012. Without further Congressional action, higher rates will go
into effect on January 1, 2013. Chapters I:2 and I:5.
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Personal Exemption Phaseout
Beginning in 2001, Congress enacted rules that required high income taxpayers to reduce their personal
and dependency exemptions when their AGI exceeded certain threshold amounts. Congress repealed the
phaseout in stages over four years beginning in 2006. Thus, in 2010, the phaseout repeal was complete.
In other words, regardless of a taxpayer’s adjusted gross income, the full amount of personal and
dependency exemptions is allowed in 2010. For example, a married taxpayer filing a joint return and
having two dependent children can claim a $14,600 ($3,650 x 4) exemption amount in 2010. Because of
sunset provisions, the full phaseout provision would have been reinstated on January 1, 2011. TRA 2010,
however, extends the complete phaseout repeal for 2011 and 2012, meaning that taxpayers will continue
to get the full amount of their personal and dependency exemptions for the two years. However, unless
Congress provides otherwise, the full phaseout returns on January 1, 2013. Chapter I:2.
Reduction in Itemized Deductions
Similar to the phaseout for personal exemptions, beginning in 2001, taxpayers had to reduce their overall
itemized deductions if their adjusted gross income exceeded a threshold amount. The reduction was
computed by multiplying excess of AGI over the threshold amount by 3% and then reducing certain
itemized deductions by this amount. Congress reduced this percentage to 2% for 2006 and 2007, to 1%
for 2008 and 2009, and to no reduction in 2010. However, beginning in 2011, the 3% reduction was
scheduled to be reinstated. TRA 2010 extends the reduction repeal for two years. Barring further
Congressional action, however, the 3% reduction percentage will return on January 1, 2013.
Chapter I:2.
Temporary Payroll Tax Cut and SE Deduction
In an effort to stimulate the economy, Congress has enacted a one-year reduction to the amount of Social
Security taxes an employee pays. Technically, this part of the payroll taxes on employees is referred to as
OASDI (old-age, survivors, and disability insurance) and is computed at the rate of 6.2% on a maximum
of $106,800 (in 2010 and (2011) of employee wages. TRA 2010 reduced the employee rate from 6.2% to
4.2% for 2011 only. Employers, however, must continue to match the full 6.2%. In addition to
employees receiving a payroll tax cut, self-employed individuals also receive a reduction. The selfemployment tax rate of 15.3% consists of OASDI of 12.4% and the Medicare tax of 2.9%. The OASDI is
reduced to 10.4%. In 2010 and earlier years, SE taxpayers receive a deduction for AGI equal to 50% of
that years’s SECA tax, but the deduction in 2011 is the sum of 59.6% of the OASDI component, plus
50% of the Medicare component. The computation of the 59.6% is as follows: .596 x .104 = .062 which
equates to the prior calculation of .50 x .124 = .062. Thus, self-employed taxpayers only pay 10.4% of
SE taxes, but are allowed to to deduct 12.4%. Chapters I:9 and 14.
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Alternative Minimum Tax
Similar to the sunset provisions above, the alternative minimum tax (AMT) has several provisions that
have been updated in the TRA 2010, including

The AMT exemption amount for 2010 and 2011 are as follows:
Single individuals
Married couples filing a joint return
Married individuals filing separate returns
2010
$47,450
72,450
36,225
2011
$48,450
74,450
37,225
If Congress does not extend these exemption amounts, much lower amounts will
return in 2012.

AMT capital gain rates will remain at 0% and 15% rather than the regular 26% and 28% rates.

Nonrefundable credits, such as the child and dependent care credit, credit for elderly and
disabled, child tax credit, adoption credit (see below), and the American Opportunity Tax
credit, will continue to be allowed to be subtracted from both the regular tax liability and the
AMT liability for 2010 and 2011. Presumably, unless Congress acts otherwise, these credits
will not be allowed for AMT purposes after 2011. Chapter I:14.
Tax Credits
Several tax credits for individual taxpayers were scheduled for reduction in amount beginning in 2011.
TRA 2010 extended or changed several credits, as follows:

The Child Tax Credit (CTC), because of the sunset provisions, was scheduled to revert back to
$500 per child under age 17 from the current $1,000 per child. The CTC was extended for 2011
and 2012. In addition, the refundable portion of the CTC also was extended through 2012.

The American Opportunity Tax Credit (AOTC) was amended in 2009 and 2010 in a variety of
ways, such as increasing the maximum amount of credit to $2,500, increasing the time for the
credit to four years from two years, and expanding the definition of qualified tuition and related
expenses. These amendments were to be revoked and the AOTC was to revert back to pre-2009
amounts. TRA 2010 extended the 2009 amendments to 2011 and 2012.

Nonbusiness energy credits were to expire after 2010 but have been extended through 2011.
However, the credit has been substantially reduced from 2009 and 2010 levels. In 2009 and
2010, the credit was 30% of the energy efficient improvements plus residential energy property
expenditures. For 2011, the credit is reduced to 10%, with a lifetime maximum of $500. This
$500 lifetime maximum includes any prior credits taken, so if a taxpayer took credits of $500 in
prior years, no credits are available in later years.
The adoption credit was changed from nonrefundable to refundable for 2010 and 2011. It is
scheduled to go back to nonrefundable in 2012. Chapter I:14.

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Investment in Qualified Small Business Stock
Taxpayers selling qualified small business stock (QSBS) held for more than five years could, for several
years, exclude 50% of the gain on such sale. A prior tax act increased the exclusion percentage to75% for
QSBS acquired after February 17, 2009 and before 2011. Qualified small business stock, in general, must
pertain to an active trade or business having assets of $50 million or less at the date the stock is issued.
SBJA 2010 increased the exclusion to 100% for QSBS acquired after September 27, 2010 and before
January 1, 2011, a very short window indeed. TRA 2010 then extended the 100% exclusion for one
additional year until December 31, 2011. In addition, the exclusion is not subject to the AMT as was the
case prior to September 28, 2010. In all cases, the QSBS must be held for more than five years to obtain
the exclusion. Chapter I:3.
Other Individual Extenders
Over the past several years, Congress made certain tax deductions temporary in nature. In other words,
the deductions had a specified date at which the deduction automatically would expire, i.e., sunset
provisions. Congress routinely extended these provisions in past years, but uncertainty caused by
Congress’ very late action in 2010 created considerable anxiety among many taxpayers. Below are
individual provisions extended for 2010 (retroactively) and 2011:





The election to deduct state and local sales taxes in lieu of state and local income taxes.
The qualified tuition deduction. The maximum deduction is $4,000, or $2,000 if the taxpayer has
AGI from $65,000 to $80,000 ($130,000 to $160,000 for married taxpayers filing a joint return).
The K-12 teachers’ deduction for out-of-pocket classroom expenses, up to $250.
The deduction for mortgage insurance premiums. These premiums generally are assessed when a
borrower has a small down payment on the purchase of a residence.
The exclusion for employer-provided educational assistance of up to $5,250 per year extended
from December 31, 2010 to December 31, 2012. Chapters I:7 (primarily) and I:3.
BUSINESS TAXPAYERS
Bonus Depreciation
The availability of bonus depreciation has been an on-again, off-again proposition. Specifically, 50%
bonus depreciation was available for 2008 and 2009, and SBJA 2010 extended this provision through
2010. TRA 2010, however, greatly expanded bonus depreciation. First, bonus depreciation has been
extended through 2012 (2013 for aircraft or long-production-period property). Second, and of major
importance, bonus depreciation has been increased to 100% for property placed in service after
September 8, 2010 through 2011. So, 50% bonus depreciation applies from January 1, 2010 – September
8, 2010 and 100% bonus depreciation applies from September 9, 2010 – December 31, 2011. For 2012,
bonus depreciation remains available, but the rate reverts to 50%. After December 31, 2012, bonus
depreciation automatically expires unless Congress decides to extend it to future years. An important
point to remember is that bonus depreciation is only allowed for qualified property, generally new
tangible personal property (the property’s original use must begin with the taxpayer). Chapter I:10.
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Bonus Depreciation on Passenger Automobiles
Consistent with the extension of bonus depreciation, the TRA 2010 extends through 2012 the $8,000
increase in first-year depreciation for passenger automobiles subject to the luxury car limits. Thus, if the
maximum depreciation for the first year is $2,960 for 100% business use, taxpayers can deduct $10,960
through 2012. Chapter I:10.
Section 179 Expense Election
Amounts allowed to be expensed under Sec. 179 have been on a proverbial roller coaster the last several
years. For example, the Sec. 179 expense limitation increased from $125,000 to $250,000 for 2008 and
2009. The $250,000 was extended through 2010 by the HIRE Act of 2010. Before the ink was barely dry
on the HIRE Act, the SBJA 2010 increased the Sec. 179 limitation to $500,000 for 2011 and 2012 with
the phaseout threshold increased to $2 million. With the phaseout threshold increase, no Sec. 179
depreciation is allowed if qualified property placed in service in a given year exceeds $2.5 million. Now,
TRA 2010 has added one more piece to the puzzle. Specifically, TRA 2010 increases the Sec. 179
limitation to $125,000 (from $25,000) for 2012, with a phaseout threshold of $500,000. As the law
stands at the moment, the Sec. 179 limitation reverts to $25,000 in 2013. The following table summarizes
the Sec. 179 expense and bonus depreciation amounts through 2013 (assuming no further changes):
Year or
Date
Sec. 179
Limitation
Phaseout Range
Bonus Depr.
Percentage
2008 - 2009
2010:
1/1 - 9/8
9/9 - 12/31
2011
2012*
2013
$250,000
$ 800,000 - $1,050,000
50%
$500,000
$500,000
$500,000
$125,000
$ 25,000
$2,000,000 - $2,500,000
$2,000,000 - $2,500,000
$2,000,000 - $2,500,000
$ 500,000 - $ 625,000
$ 200,000 - $ 225,000
50%
100%
100%
50%
0%
*2012 amounts will be adjusted for inflation. Chapter I:10.
Extension of General Business Credit Carryback
Under law prior to January 1, 2010, the general business credit could only be carried back for one year
and was not eligible to be used to reduce a taxpayer’s alternative minimum tax. The SBJA 2010 now
allows eligible small businesses to carryback general business credits up to 5 years. And, for 2010 only,
the credit may also reduce AMT as well as the regular tax liability. An eligible small business is, in
general, a corporation, partnership, or sole proprietorship with average gross receipts for the three
immediately prior years of less than $50 million. Chapter I:14.
Business Tax Extenders
TRA 2010 extends for two years a number of business tax provisions which that had expired at December
31, 2009. Most of these extenders are highly specific, including railroad track maintenance credit, film
and television production costs, five-year write-off of farm machinery and equipment, and tax incentives
for empowerment zones. In addition, the research credit has been extended through 2011.
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S Corporation Built-in Gains
S corporations that formerly were C corporations may have to pay a special tax on assets that had socalled built-in gains at the date of the S election. This built-in gain applies for the first ten years after
becoming an S corporation. The ten year period was reduced to seven years for 2009 and 2010. SBJA
2010 reduced the waiting period to five years for 2011. Chapter C:11
Start-up Costs Deduction Increased
Start-up costs are not deductible unless the taxpayer elects to deduct them under Sec. 195. Prior to 2010,
Sec. 195 allowed taxpayers to deduct the first $5,000 of start-up costs and then amortize the remaining
costs over 180 months. Further, if the taxpayer had more than $50,000 of start-up costs, the taxpayer had
to reduce the $5,000 first year deduction by the amount the start-up costs exceeded $50,000. Thus, if
start-up costs exceeded $55,000, all costs must be amortized over 180 months beginning with the month
the active trade or business began. SBJA 2010 increased the $5,000 to $10,000 and the $50,000 to
$60,000 for 2010 only. Chapter C:3.
ESTATE AND GIFT TAX
Estate Tax Reinstated
As of January 1, 2010, due to the operation of sunset provisions, the estate tax was automatically repealed
and was scheduled to return in 2011 at pre-2001 Act levels. Several very high wealth individuals died in
2010, and their estates were not subject to any estate tax under the rules in effect at date of death.
However, with the repeal of the estate tax, the assets of the decedent, except for a limited amount, were
not permitted to be stepped-up to fair market value. Rather, the basis of the assets transferred to
beneficiaries was determined using a modified carryover basis system. Congress finally reached an
agreement in TRA 2010, and the estate tax has been reinstated retroactive to January 1, 2010 along with
assets being stepped up to fair market value at date of death. However, the estates of decedents who died
in 2010 are allowed to make a special election that allows the estate not to have the estate tax apply and
employ the modified carryover basis system referred to above. Thus, estates can elect the repealed estate
tax scenario or use the reinstated estate tax rules. Chapter C:13.
Estate and Gift Tax Exemption Increased to $5 Million
In 2009, prior to repeal, the unified credit was the equivalent of the tax on $3.5 million for estates and $1
million for gifts. The TRA 2010 has increased the estate tax exemption amount to $5 million for the
years 2010, 2011, and 2012 for both the estate tax and the generation skipping tax (GST). After 2012,
absent further Congressional action, the unified credit exclusion amount will decrease to $1 million for
both the estate tax and GST. Further, the unified credit exclusion amount for gifts will continue to be $1
million in 2010, but will increase to $5 million for 2011 and 2012. And, beginning in 2013, the exclusion
for gifts will return to $1 million. Because of the uncertainty of Congressional action, planning remains
very restricted because of the sunset provisions. Chapters C:12 and C:13.
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Top Tax Rate for Estates and Gifts Set at 35%
In 2009, the top marginal estate tax rate was 45%. For 2010 through 2012, the top estate tax rate has been
reduced to 35%. In a roundabout way, all estates subject to estate tax, i.e., those estates exceeding $5
million are subject to a flat 35% rate. The reasoning is as follows: all transfers exceeding $500,000 are
subject to tax at 35%. Since the exemption amount is $5 million, the entire excess amount will be taxed
at 35% as the $500,000 transfer amount was exceeded. The gift tax has been re-unified with the estate tax
and cumulative taxable gifts exceeding $5 million also will be subject to a flat 35% tax rate. As is the
case with most of the new provisions in the estate and gift area, the 35% rate applies only through 2012.
Thus, absent Congressional action, the top estate and gift rate will return to 55% in 2013.
Chapters C:12 and C:13.
Portability of the Estate Tax Exemption
Prior to 2011, both a husband and wife had estate tax exemption amounts that could be used only by that
individual. For example, in 2009 when the exclusion was $3.5 million, the husband could use $3.5
million at his death, and the wife could use $3.5 million at her death. This situation was the case even if
one spouse’s estate was much smaller than $3.5 million and the other spouse’s estate was considerably
larger than $3.5 million. For many years, attorneys used a technique called “credit shelter trusts” to make
sure that the $3.5 million was fully utilized after the death of the second-to-die spouse. Under TRA 2010,
the estate exemption is now portable between spouses for 2011 and 2012, which means that any exclusion
amount that remains unused at the first spouse’s death can be used by the second spouse. For example,
the husband dies in 2011 and his estate is $2 million. His remaining $3 million would be added to the
wife’s $5 million, so she would now have an estate tax exemption amount of $8 million. While this
provision is attractive, it applies only for 2011 and 2012. Consequently, the usefulness of this provision
is limited given its sunset nature. Chapter C:13.
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Appendix
2011 Income Tax Rate Schedules
Single
If taxable income is:
Not over $8,500 . . . . . . . . . . . . . . . . . . .
Over $8,500 but not over $34,500 . . . . .
Over $34,500 but not over $83,600 . . . .
Over $83,600 but not over $174,400 . . .
Over $174,400 but not over $379,150 . .
Over $379,150 . . . . . . . . . . . . . . . . . . . .
The tax is:
10% of taxable income.
$850.00, plus 15% of the excess over $8,500.
$4,750.00, plus 25% of the excess over $34,500.
$17,025.00, plus 28% of the excess over $83,600.
$42,449.00, plus 33% of the excess over $174,400.
$110,016.50, plus 35% of the excess over $379,150.
Head of Household
If taxable income is:
Not over $12,150 . . . . . . . . . . . . . . . . . .
Over $12,150 but not over $46,250 . . . .
Over $46,250 but not over $119,400 . . .
Over $119,400 but not over $193,350 . .
Over $193,350 but not over $379,150 . .
Over $379,150 . . . . . . . . . . . . . . . . . . . .
The tax is:
10% of taxable income.
$1,215.00, plus 15% of the excess over $12,150.
$6,330.00, plus 25% of the excess over $46,250.
$24,617.50 plus 28% of the excess over $119,400.
$45,323.50, plus 33% of the excess over $193,350.
$106,637.50, plus 35% of the excess over $379,150.
Married, Filing Jointly and Surviving Spouse
If taxable income is:
Not over $17,000 . . . . . . . . . . . . . . . . . .
Over $17,000 but not over $69,000 . . . .
Over $69,000 but not over $139,350 . . .
Over $139,350 but not over $212,300 . .
Over $212,300 but not over $379,150 . .
Over $379,150 . . . . . . . . . . . . . . . . . . . .
The tax is:
10% of taxable income.
$1,700.00, plus 15% of the excess over $17,000.
$9,500.00, plus 25% of the excess over $69,000.
$27,087.50, plus 28% of the excess over $139,350.
$47,513.50, plus 33% of the excess over $212,300.
$102,574.00, plus 35% of the excess over $379,150.
Married, Filing Separately
If taxable income is:
Not over $8,500 . . . . . . . . . . . . . . . . . . .
Over $8,500 but not over $34,500 . . . . .
Over $34,500 but not over $69,675 . . . .
Over $69,675 but not over $106,150 . . .
Over $106,150 but not over $189,575 . . .
Over $189,575 . . . . . . . . . . . . . . . . . . . .
The tax is:
10% of taxable income.
$850.00, plus 15% of the excess over $8,500.
$4,750.00, plus 25% of the excess over $34,500.
$13,543.75, plus 28% of the excess over $69,675.
$23,756.75, plus 33% of the excess over $106,150.
$51,287.00, plus 35% of the excess over $189,575.
Estates and Trusts
If taxable income is:
Not over $2,300 . . . . . . . . . . . . . . . . . . .
Over $2,300 but not over $5,450 . . . . . .
Over $5,450 but not over $8,300 . . . . . .
Over $8,300 but not over $11,350 . . . . .
Over $11,350 . . . . . . . . . . . . . . . . . . . . .
The tax is:
15% of taxable income.
$345.00, plus 25% of the excess over $2,300.
$1,132.50, plus 28% of the excess over $5,450.
$1,930.50, plus 33% of the excess over $8,300.
$2,937.00 plus 35% of the excess over $11,350.
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