What the Bill Extending the Bush Tax Cuts Means To You

The television pundits are still arguing over whether it was a tax cut bill or an extension of current taxes bill. Well, it turns out they're both right.

The 1,900 page bill that finally made its way through congress extended the Bush tax cuts but also cut taxes by lowering the payroll tax for all workers by two percentage points.

Is it a win-win? That depends on with whom you speak. While it extends the cuts for everyone including the super-rich, it also leaves has its share of losers.

Winners and losers

The biggest winners appear to be individual taxpayers who would have seen their taxes rise if the measure hadn't passed. On the other hand, some bond investors could take a hit if the bill triggers a sell-off in U.S. Treasuries.

The reason that might happen is that earlier this month, Moody's Investment Service said the tax cut extension bill increases the possibility it would put out a negative outlook on the government's AAA credit rating because the bill increases the nation's debt by more than $800 billion.

There also are some things that got dropped in the compromise legislation. A provision that would have taxed earnings of hedge and private equity fund executives as income rather than capital gains was left out. But so was language that would have helped small business owners by removing a requirement that they issue 1099 forms to any vendor that receives at least $600 a year.

Individual benefits

As for individual income and payroll taxes, the bill extends the Bush-era tax rates that were enacted earlier in the decade. This basically prevents taxes from rising to pre-2001 levels for all taxpayers through 2012. Also, approximately 15 million lower-income workers who would have had their income taxed now get to remain off the tax rolls.

Another big win is the reduction in Social Security (FICA) taxes. The bill trims two percentage points from the employee's portion of the 6.2 percent tax. How much you'll save depends on your income, but it could be as much as $2,136 for those earning more than $106,800, which is the maximum amount subject to Social Security tax.

The bill also contains a two-year patch for what's known as the alternative minimum tax or AMT, retroactive to January 2010. The AMT was set up to ensure that people with high incomes pay taxes. But it isn't indexed for inflation and it has come to include middle-class taxpayers. The patch spares an additional 21 million taxpayers this year.

Investors

For investors, the bill extends for two years the current tax rates on long-term capital gains and dividends. The top rate for both will remain at its historic low of 15 percent. The rate will remain zero for couples with taxable income below $69,000.

According to the Tax Policy Center, more than half of the benefit of this extension will go to people with incomes above $100,000. Absent the extension, the top rate on long-term gains would have risen to 20 percent, while the top dividend rate could have risen to as high as 39.6 percent.

Among the benefits extended through 2011 are deductions for teacher expenses and for state sales taxes in lieu of state income taxes. Lawmakers also extended through 2011 the provision allowing taxpayers over age 70 1/2 to make tax-free donations of IRA assets to qualified charities.

Several education benefits were also extended through 2012. Not renewed, however, was a property-tax deduction for people who didn't itemize their deductions.

Estate taxes

The top estate-tax rate falls to 35 percent and the exemption rises to $5 million an individual. The bill also allows executors of 2010 estates to elect whether to use 2010 rules or 2011 rules. The choice will help heirs who would pay more as a result of the lapse of the estate tax in 2010 and a corresponding rise in capital-gains taxes.

The new provisions will cut by at least a third the number of estates subject to the tax, which was paid by about 5,500 estates in 2009, according to Tax Policy Center estimates.

Also for the first time, estate, gift and generation-skipping taxes will be "unified" so that one $5 million exemption per individual applies to all three. This will make it much easier for wealthy taxpayers to make gifts during life to grandchildren.

Other benefits

Here are some other benefits of the tax bill:

• You could make tax-free distributions of up to $100,000 of IRA assets to charities per year. The bill allows donations made in January, 2011, to be treated as if made in 2010. By giving their IRA assets to charity, taxpayers don't have to claim the distributions as income, so they avoid being disqualified for other tax breaks and deductions.
• Through 2011, teachers will still be able to file for up to $250 in deductions for classroom expenses related to books, supplies, computer equipment and other materials. This is an above-the-line deduction, which lowers adjusted gross income. For teachers, the deduction takes a small bite out of the reported average of $356 teachers spend out-of-pocket on average for school supplies and other resources, according to the National School Supply & Equipment Association, a trade association for educational product companies. The extension would apply to elementary and secondary school teachers, and doesn't include non-athletic supplies used in health and physical education courses.
• Taxpayers who itemize deductions will be able to deduct state and local sales taxes through 2011. This helps residents of states that don't have an income tax because they can use it in place of the itemized deduction currently allowed for state and local income taxes.
• Several education credits and breaks would be extended. Families of college students would be able to claim a deduction of up to $4,000 for qualified education expenses through 2011. The American Opportunity Tax Credit would be extended through 2012, and allows taxpayers to claim a credit of up to $2,500. Taxpayers can only use one and both have specific income requirements.
• The annual contribution amount for Coverdell Education Savings Accounts, tax-exempt savings accounts, would also stay at $2,000 through 2012 and money from the accounts could still be used for elementary and secondary school expenses; without the extension the contribution limit would fall to $500 and money could only be used for post-secondary expenses.
• Also extended is the higher phase out levels for the up to $2,500 above the line student loan interest deduction. They'll remain $55,000 to $70,000 or $110,000 to $140,000 for joint filers.