How the new tax law may affect you

What it means for your take-home pay, investments, and more.

How the new tax laws may affect you

Last December, President Obama signed the tax bill into law. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 temporarily extends the 2001 and 2003 federal income tax rate cuts, extends unemployment insurance for 13 months, provides new payroll tax breaks, reinstates the estate tax, and more.

The good news: The new law will give taxpayers a bit of clarity—and an opportunity to plan with relative confidence knowing that the playing field won’t change dramatically, at least for two years. But beyond that, an increase in the Medicare tax for upper-income Americans is slated for 2013. And more changes are likely in the future, given the pressure to raise revenues to reduce the deficit, and talk of sweeping tax reform.

“Passage of this tax law ensures that individuals at all income levels won’t face an automatic tax increase this year,” says Shahira Knight, Fidelity’s vice president of government relations. “The law provides taxpayers with some certainty, but Congress will be back at the table having the same debate in two years”

So what can you do now? Let’s take a look at how the new law may impact you in four key areas: your take-home pay, your investments, your estate and gifting plans, and, if you’re over age 70½, qualified charitable distributions from your IRA. We’ll summarize what’s changed, and what you should be thinking about for both year-end and longer-term tax planning.

New tax laws

How it affects your take-home pay

NEW—Payroll tax relief: There is now a 2 percentage point reduction in an employee’s share of the Social Security portion of the FICA tax, from 6.2% to 4.2%, in 2011. So, if you make $80,000 a year, you could take home an additional $1,600 a year in 2011.

What to consider now:

  • Increase any tax-advantaged retirement account contributions: If you are not already maximizing pretax contributions to your 401(k) plan, 403(b) plan, or other workplace savings plan, consider increasing your payroll deduction by 2%, or at least enough to garner the full company match. In 2011 you can contribute up to $16,500 to 401(k) plans (up to $22,000 if you’re 50 or older), and $5,000 to IRAs ($6,000 for ages 50 and older). Fidelity believes this is a smart plan of action, unless you have high interest-rate credit card debt. If so, consider using the extra money from the payroll tax relief to pay down your plastic first.

What to consider going forward:

  • Automatic increases in your workplace savings plan: If you are still not maximizing your workplace savings contributions, consider increasing automatic payroll deductions in 2011.
  • If you have a 401(k) or 403(b) with Fidelity, you can review and increase you contribution rate, or sign up for automatic increases, on NetBenefits (log in required).

Extended—2001 and 2003 income tax cuts: The new tax law provides a two-year extension of the 2001 and 2003 Bush-era income tax cuts (through 2012), regardless of a person’s income level. This means there will be no change in the income tax rates this year or next year, although the alternative minimum tax (AMT) patch extends only through 2011 and is not indexed for inflation in 2011.

What to consider now:

  • A Roth IRA conversion: You may want to consider converting a traditional IRA or other eligible retirement balance to a Roth IRA.1
  • Your income and deductions: Tax advisers often suggest that those who itemize deductions should defer income into future tax years while accelerating deductions into the current tax year. While you may end up with virtually the same tax bill, you would pay it at a later date. In the meantime, you may be able to benefit from the use of that money. Since tax rates will stay the same next year, this popular year-end tax move may be helpful in 2011, with one important exception. If you are or may be subject to the AMT, you may be better off doing the opposite. As always, you should consult your tax adviser.

Extended—AMT relief: There is now a two-year extension (through 2011) of the AMT "patch".

How it affects your investments

Extended—Capital gains tax: The top rate on long-term capital gains will remain at 15% for 2011 and 2012.

Extended—Qualified dividends tax: The top rate for qualified dividends—those on certain stocks held longer than 60 days—will remain at 15% through 2012.

What to consider now:

  • Employ an effective tax-loss harvesting strategy: Tax-loss harvesting is the practice of selling investments that have lost value to offset current-and future-year capital gains. Unlike one-time or occasional-loss sales, however, a systematic tax-loss harvesting strategy requires diligent investment tracking and detailed tax accounting.
  • Exploit the 0% capital gains rate: You also may have the opportunity to eliminate taxes on the capital gains you realize from taxable accounts. In 2011 and 2012, taxpayers in the 10% and 15% federal income tax brackets can realize long-term capital gains (and qualified dividends) without triggering capital gains taxes. For tax year 2011, the 15% bracket tops out at $68,000 of taxable income for married couples filing jointly.  For tax year 2012, the 15% tax bracket tops out at $69,000 for joint filers. The result: If your taxable income falls into the two lowest tax brackets, selling stocks held longer than a year may be a highly tax-efficient way to generate cash flow. If you’re retired, this strategy may be most advantageous if you have a relatively high proportion of your retirement assets in taxable accounts.

What to consider going forward:

  • Plan ahead for future tax increases: No one can predict how or when tax rates might rise or what form proposed tax reforms may take. But at least one new tax is already slated to hit the net investment income of upper-income taxpayers in 2013: an additional 3.8% Medicare tax, which will affect married couples filing jointly with a modified adjusted gross income (MAGI) of more than $250,000 ($200,000 for single filers). The tax will apply to the lesser of net investment income or MAGI over the threshold. Investment income would include income from interest, dividends, capital gains, annuities, rents, and royalties.

    It’s not too soon to begin preparing for this 2013 tax change. You’ll want to consider maximizing savings in tax-advantaged accounts such as IRAs and 401(k)s, because withdrawals from them will not be included when determining investment income for the new Medicare tax. Further, qualifying Roth IRA withdrawals aren’t considered investment income or an addition to your MAGI under current law—possibly making conversions and contributions to Roth-type accounts more relevant for the near term. If you don’t have a Roth IRA, you may want to consider converting to one. Get the details in Viewpoints: Tax-savvy Roth IRA conversions.

How it affects small businesses and the self-employed

NEW—Business Expensing: The new law provides for 100% expensing of qualified capital investments in 2011 and 50% expensing in 2012.

How it affects estate planning and gifting

NEW—Estate tax rate and exclusion: The new law reinstates the estate tax in 2011 and 2012 at a maximum rate of 35% with a $5 million exemption per person. This compares to a 45% maximum rate and $3.5 million exclusion in 2009. The new rules will sunset after 2012. Beginning in 2013, there will be a $1 million per person exclusion with a 55% estate and gift tax rate unless further legislation is enacted.

Here are some additional estate tax changes you should know about:

  • Portability. New portability rules allow any unused exemption to be passed to a surviving spouse, so a married couple can exempt up to $10 million.
  • Estates of decedents who died in 2010. The new law gives executors of these estates a choice: distribute assets to heirs estate-tax-free but with a carryover basis (generally the original purchase price), or step up the basis to the market value (generally at time of death) and pay the 35% rate on anything above the $5 million exemption. A step-up in basis means the value of an appreciated asset is readjusted at a higher market value for tax purposes upon inheritance versus what the value of the asset was when it was originally purchased.
  • Gift Tax exemption. The new law reunifies the federal estate tax exemption and the federal gift tax exemption. This means that the new lifetime gift tax exemption is $5 million per person ($10 million per couple) beginning in 2011. Taxable gifts made in 2011 and 2012 will be taxed at the rate of 35%.
  • Generation Skipping Transfer Tax (GSTT). Beginning in 2011, the generation skipping transfer tax exemption will also be $5 million per person ($10 million per couple) with a 35% tax rate. Note: The GSTT is not portable.
  • Extension of time for certain filings. The new law extends the time to file certain estate and gift tax returns to nine months after the enactment of the new law.

What to consider going forward:

  • Make tax-smart charitable year-end contributions. Donating long-term appreciated securities may be a particularly tax-savvy strategy. As a general rule, donations of long-term appreciated securities (either stock or mutual funds) directly to a qualified charity are deductible at their fair market value on the date of contribution, and you don’t pay capital gains taxes on the donated security. For those considering a major gift in 2011, combining a charitable gift with a Roth IRA conversion may help offset the tax cost of the conversion and perhaps allow you to convert a larger amount at a lower tax cost. Read: Tax-savvy Roth IRA Conversions.
  • Set up a meeting with your tax adviser or estate planning attorney to review your estate plan and make any necessary changes.
  • Consider a Grantor Retained Annuity Trust (GRAT): A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust that pays a fixed annuity to the grantor for a defined period, then pays the remainder to a non-charitable beneficiary. Contrary to expectations, the new law did not restrict GRATs. And, with the increased gift tax exemption, a grantor can now potentially put even more money into a GRAT without having to pay gift taxes. Current low interest rates are also beneficial to GRATs, because they help increase the value of the annuity while lowering the value of the remainder interest. So, the grantor may potentially use even less of the new gift tax exemption. As always, consult your Fidelity representative or speak with your attorney or tax adviser before making any decisions.

How it affects retirees

Extended—qualified charitable distributions (QCDs) from IRAs: The new tax law extends provisions of the Pension Protection Act of 2006 that allow investors age 70½ or older to make a qualified distribution of up to $100,000 from an IRA directly to a qualified charity for both 2010 and 2011.

Not extended—Minimum Required Distribution (MRD) suspension: The new tax law does not extend the 2009 suspension of MRDs. Retirees are generally required to take MRDs from their retirement accounts for the year in which they turn 70½, and all subsequent years, by December 31. Failure to comply with this IRS regulation could result in a 50% penalty on the amount that should have been distributed.

What to consider now:

  • Make sure you take an MRD. If you’re 70½ or over, take a moment to ensure you’ve met your MRD obligation for 2010. If  you were born between July 1, 1939, and June 30, 1940, your deadline is April 1, 2011. Just remember, you’ll have to take two MRDs in 2011 (one for 2010 and one for 2011).
  • Think about QCDs and MRDs together. Qualified charitable distributions from IRAs made directly to qualifying charities count toward any MRD. For example, if you have a $75,000 MRD for 2011, you can make an IRA distribution of up to $100,000 directly to a qualifying charity and $75,000 of that $100,000 is counted as your MRD.

What to consider going forward:

  • Talk to your tax adviser about IRA strategies for 2011. If you are a high-net-worth investor with high IRA balances, next year may be a tax-efficient time to give away some of that money.

Next steps

  • Increase your 401(k) or 403(b) contribution rate.
  • Get guidance from a Fidelity Representative, call your plan's toll-free number.
  • Get a discount on tax software.

Views expressed are as of 3/14/2011 and may change based on market and other conditions. Unless otherwise noted, the opinions provided are not necessarily those of Fidelity Investments.

The tax and estate planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.

1. A distribution from a Roth IRA is tax free and penalty free provided that the five-year aging requirement has been satisfied and at least one of the following conditions is met: you reach age 59½, die, become disabled, or make a qualified first-time home purchase.

Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917

Investment and workplace savings plan products and services distributed through investment professionals provided by Fidelity Investments Institutional Services Company, Inc., 100 Salem Street, Smithfield, RI 02917.



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