What You Should Know About the New Tax Law
(And What to Do About It)

To help the economy recover, the tax law passed in the last days of 2010 extended many tax breaks for consumers and small businesses, and added a surprising cut in required contributions to Social Security. Here are the highlights, along with some implications for retirement planning.

YOU’LL KEEP MORE OF YOUR OWN MONEY.

• A temporary cut in payroll tax. For 2011, employees have to contribute only 4.2% of gross income to Social Security instead of 6.2%. Self-employed people also get this break, but still have to pay the 6.2% employer portion of the tax.
• No income tax increase (yet). The 35% top rate continues through 2012. “Stealth taxes” – caps on itemized deductions and personal exemptions – won’t return until 2013 at the earliest.
• Low tax rates on investment profits. Through 2012, dividends and long-term capital gains remain tax-free in the 10% and 15% tax brackets. In higher brackets, the top rate is still 15%.
• Child tax credit extended. This $1,000 per child credit now applies through 2012. Low-income families may get a partial refund based on this credit even if they owe no tax.
• Shelter from the AMT. Increased exemption amounts for 2010 and 2011 will spare many middle-income taxpayers from having to pay the Alternative Minimum Tax.
• Higher deductions for long-term care insurance premiums. Depending on your age, you can deduct up to $4,240 in 2010 premiums, with a further increase for 2011.

YOU CAN GIVE MORE, TAX-FREE.

• Tax-free gifts to charity from an IRA. In 2010 and 2011, taxpayers who are 70½ or older can donate up to $100,000 from an IRA without any tax or penalty.
• A boost in the lifetime gift tax exemption to $5 million. Gifts over $13,000 count against this lifetime exemption, except for any size gift to charity, your spouse, or a political organization; or payments to an educational institution or a medical facility.

EDUCATION GETS A BOOST.

• More coverage with Coverdells. In 2011 and 2012, Coverdell Education Savings Accounts may be used to pay expenses for primary and secondary school as well as college. You can contribute up to $2,000 a year.  Don't forget, Union Plus Credit Cardholders may also qualify to get $500 when they open a 529 college savings or a pre-paid tuition account.
• A continuing credit for college costs. Through 2012, the American Opportunity Tax Credit provides up to $2,500 a year for four years of tuition and expenses. Income limits apply.
• Reimbursement for teachers’ spending. Teachers who pay for educational supplies themselves are eligible for a $250 deduction, but only for 2010 and 2011.

THE ESTATE TAX IS BACK – SIMPLER THAN BEFORE.

• Surviving spouses inherit any unused exemption. In 2011 and 2012, heirs benefit again from a “step-up” in basis. Estates valued at $5 million or less are exempt from estate tax; over $5 million, a 35% rate applies. Unused exemptions can be carried over to a surviving spouse.
• Two options for estates filing for 2010. They can use the method for 2011-12 (see above); or pay no estate tax, but heirs carry over the deceased person’s basis for assets they inherited.

OTHER PROVISIONS OF INTEREST:

• OTC drugs banned from flexible spending accounts. Starting in 2011, FSAs may be used only to buy prescription drugs and insulin, not over-the-counter meds.
• Expensing any business asset. If you run a small business, you can expense assets of any size bought in 2011, instead of having to claim depreciation over time.
• Unemployment benefits now available for 99 weeks. This extension applies through 2011.  Check out additional Union Plus layoff assistance for union families here.

Six action steps to consider:

1. Plan now what to do with your Social Security tax cut.
   Since for most people it means a slight bump in take-home pay, it will be easy to spend. If you’d rather save it, arrange automatic transfers of 2% of your gross pay into a savings account. (6.2% minus 4.2% = 2%.) For example, if your gross pay is $2,000 paid every two weeks, have $40 transferred to savings every pay period. $40 x 26 weeks = $1,040.
2. Consider a Roth IRA (or Roth 401(k)) for new retirement savings.
   Tax rates are likely to rise after 2012. If you pay today’s lower rate now on money you contribute to a Roth, you won’t have to pay a higher rate later when you withdraw it. And everything it earns between now and then will be tax-free.
3. Converting a Traditional IRA to a Roth may still make sense.
   The income limit has disappeared – so even if you missed the opportunity to convert in 2010 and split the income between 2011 and 2012, consider a conversion while tax rates are still low. If you take the tax hit now, you won’t risk facing a higher rate on withdrawals in retirement.
4. If you invest outside a retirement account, take your time.
   Give plenty of thought to choices before you invest, so short-term declines don’t stampede you into selling quickly. Stocks (including stock mutual funds and ETFs) that you sell within a year are taxed at your usual tax rate, not the more favorable rate for long-term gains. Also, frequent buying and selling has been shown to reduce potential returns.
5. Let Uncle Sam help you buy long-term care insurance.
   After adding together all your medical expenses, any amount exceeding 7.5% of your adjusted gross income is deductible if you itemize. This includes a portion of LTCI premiums.
6. Don’t stop thinking about your estate.
   You may not expect it to be worth $5 million or more, but who’s to say the exemption amount will stay that high in the future? At least make sure you have an up-to-date will. (Through the Union Plus Legal Service, union members can receive a 30% discount and a 30-minute free consultation with a lawyer in their area. Call 1-888-993-8886 or visit UnionPlus.org/Legal.) Also, check the way your assets are titled. For example, an ex-spouse’s name remaining on a deed means he or she would inherit the property when you’re gone.

In general, a relatively low-tax-rate environment seems likely to prevail for the next two years – a situation worth taking advantage of. We do recommend consulting a financial planner or tax advisor before making decisions that could affect your tax liability.