Limited Window of Opportunity on Bush-era Tax Breaks

Last December, Congress extended a number of the Bush-era tax breaks, but only for a limited length of time. It is probably a safe bet that most won’t get extended further, considering the size of the national debt. Although numerous tax breaks were extended, only a few provide you with an opportunity to take actions that can reduce your tax bite. But if you want to take advantage of those tax breaks, you need to act this year or next. Here is a list of those extended tax breaks and what will happen when they expire.

Individual Tax Rates – The Bush-era tax cuts reduced and replaced individual tax rates with six tax brackets that increase with income: 10, 15, 25, 28, 33, and 35 percent. They will revert to their original higher levels of 15, 28, 31, 36, and 39.6 percent beginning in 2013. That will result in the lowest bracket increasing by 5 percentage points and the highest bracket increasing by 3.6 percentage points, affecting all taxpayers from low to high incomes. In certain circumstances, it may be appropriate to accelerate income to take advantage of the lower rates.

Capital Gains and Qualified Dividends – Under the Bush-era tax cuts, the maximum tax on long-term capital gains (assets owned for more than one year) was reduced from 20 percent to 15 percent for taxpayers in the 25 percent and higher tax brackets. The tax cuts also provided for a zero tax rate to the extent a taxpayer is in the 10 and 15 percent income tax brackets. These lower rates will revert to the higher rates in 2013, impacting taxpayers in all tax brackets. Do you have potential capital gains that you might sell before 2013 to take advantage of the current lower rates?

American Opportunity Tax Credit – The American Opportunity Tax Credit (AOTC) replaced the Hope Education Credit in 2009 and provides a maximum tuition credit of $2,500, of which up to 40 percent can be refundable and applies to the first four years of post-secondary education. This enhanced credit will expire after 2012 and is set to be replaced by the Hope Education Credit that provides a reduced maximum credit of $1,800, of which none is refundable; the Hope credit is only applicable to the first two years of post-secondary education. This will primarily affect lower income families. Note: The administration wants to make the AOTC permanent so watch for further developments.

Home Energy-Savings Improvement Credit – This on-again, off-again credit has been extended for one additional year, 2011, but it has been substantially reduced and only provides a credit up to $500 (it was $1,500 in 2010) and a reduced credit percentage of 10 percent (down from 30 percent in 2010). In addition, the $500 credit limit is reduced by any credit taken after 2005. To take advantage of this credit for energy-saving exterior windows, skylights, doors, insulation, heating systems, etc., you need to act before the end of 2011.

Coverdell Educational Accounts – The $2,000 maximum contribution to Coverdell education accounts will revert to a $500 maximum after 2012. If you want to maximize the contributions for a child’s future education needs, you need to do so before 2013.

Sales Tax Deduction – If you are planning to make a big ticket purchase and want to deduct the sales tax [http://www.irs.gov/individuals/article/0,,id=152421,00.html] as part of your itemized deductions, you need to act before the end of 2011. The option to deduct the larger of state and local income tax or sales tax expires after 2011.

Tax-Free IRA to Charity Distributions - The provision that permits taxpayers age 70½ and over to make direct distributions (up to $100,000 per year) from their Traditional or Roth IRA account to a charity will expire at the end of 2011. The distribution is tax-free, but there is no charitable deduction. This provision can be very beneficial to taxpayers who have Social Security income and/or do not itemize their deductions.

If you have questions related to how these or other tax benefits might fit into your tax planning, please call our office.