At this time last year, income tax planning was particularly challenging. Several tax deductions had already expired, and significant changes, including new, higher income tax rates, were scheduled to take effect at the end of the year. Legislation passed in mid-December, however, hit the “reset” button, reinstituting already-expired deductions, and extending major tax provisions–including lower rates–for an additional one to two years.
As a result of the December legislation, 2011 tax planning takes place in an environment characterized by something that was missing last year–a relative degree of certainty. That being said, here are some things to keep in mind as you consider your current tax situation.
- Federal income tax rates –The same six federal income tax rates that applied in 2010 will continue to apply in 2011 and 2012. So, depending on your taxable income, you’ll fall into either the 10%, 15%, 25%, 28%, 33%, or 35% rate bracket. Remember, though, that all of your taxable income is not necessarily taxed at that rate–instead, the rate at which you pay tax generally increases as your income increases. For example, if you’re a single individual with 2011 taxable income of $100,000, you fall into the 28% tax bracket. However, your first $8,500 of taxable income is taxed at 10%, your next $26,000 of taxable income is taxed at 15%, and your next $49,100 in taxable income is taxed at 25%. Only $16,400 of your taxable income is actually taxed at 28%.
- Rates for long-term capital gains and qualifying dividends –As in 2010, long-term capital gains and qualifying dividends continue to be taxed at a maximum rate of 15% through 2012; if your income (including any long-term capital gains and qualifying dividends) puts you in the 10% or 15% income tax brackets in 2011 and 2012, a special 0% rate will generally continue to apply.
- Alternative minimum tax (AMT) –While regular income tax rates and the maximum rates that apply to long-term capital gains and qualifying dividends were extended through 2012, the latest AMT “fix” (in the form of increased AMT exemption amounts) is effective only through 2011. So, if you think you may be subject to the AMT this year, the good news is that you know ahead of time what the relevant exemption amounts are ($74,450 for married individuals filing jointly, $48,450 for unmarried individuals, $37,225 for married individuals filing separately); the bad news is that the AMT situation for 2012 remains up in the air. You can probably expect another AMT fix later this year, but as it stands now, AMT exemption amounts will drop significantly in 2012, dramatically increasing the number of taxpayers ensnared by this parallel tax system.
Available for 2009 and 2010, the Making Work Pay tax credit was a refundable tax credit equal to the lesser of 6.2% of earned income or $400 ($800 for married couples filing joint returns); the credit was phased out for those with higher incomes. The tax credit was not extended to 2011, but the December legislation created a new one-year 2% reduction in employee