Napier & Company, LCC

Extension of Bush Tax Cuts in the 2010 Tax Relief Act

The heart of the recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” is a two-year extension of the Bush tax cuts. But what, exactly, are the Bush tax cuts? Here's a primer:

Bush tax-cut legislation. The Bush tax cuts refer primarily to tax changes in two major pieces of legislation back in 2001 and 2003. Key elements of this legislation included:

· A lowering of individual income tax rates from 15%, 28%, 31%, 36%, and 39.6% to 10%, 15%, 25%, 28%, 33%, and 35%.

· A doubling of the child tax credit from $500 to $1,000.

· A gradual reduction in estate taxes, culminating in a one-year repeal in 2010 (but reinstatement in 2011).

The crucial element of the 2001 tax cuts, at least for current purposes, is that they were temporary, set to expire at the end of 2010 unless Congress acted to extend them.

In the 2003 legislation, the law cut the top capital gains rate from 20% to 15% and a cut in the top individual rate on dividends from 35% to 15%. Under the 2003 legislation, the capital gains and dividends cuts were set to expire after 2008, but they were later extended for two additional years (until 2010).

New law extends lower rates for all taxpayers for two years. Over the past several years, a lot of political energy has been expended on the issue of whether the favorable individual income tax rates, which were set to expire at the end of 2010, should be extended for everyone, or for everyone except the “rich.”

The new law settles the issue by extending the lower rates for all taxpayers through 2012. Under the new law, the rates that have been in effect in recent years—10%, 15%, 25%, 28%, 33%, and 35%—will remain in place.

New law extends lower capital gains rates for two years. Capital gains, generally speaking, refers to the profits realized on sales of non-inventory assets. For individuals, capital gains are generally taxed at a preferential rate in comparison to ordinary income.

The amount of tax depends on both the investor's tax bracket and how long the investment was held before being sold. Short-term capital gains on investments held for a year or less are taxed at the investor's ordinary income tax rate. Long-term capital gains, which apply to assets held for more than one year, are taxed at a lower rate than short-term gains.

Since 2008, the tax rate on long-term capital gains has been 0% for individuals in the 10% and 15% income tax brackets, and 15% for everyone else. However, those rates were scheduled to expire at the end of 2010, as explained above, with the result that in 2011 the long-term capital gains tax rate would have risen to 20% (10% for taxpayers in the 15% tax bracket) if Congress had not acted.

The new legislation forestalls these increases by extending the 0% and 15% long-term capital gains tax rates for two years (through 2012).