Taxpayers should make sure they are aware of many important changes to the tax law before they complete their 2010 federal income tax return.
Here are several important changes that the IRS wants you to keep in mind when you file your 2010 federal income tax return in 2011.
Health Insurance Deduction Reduces Self Employment Tax In 2010, eligible self-employed individuals can use the self-employed health insurance deduction to reduce their social security self-employment tax liability in addition to their income tax liability. As in the past, eligible taxpayers claim this deduction on Form 1040 Line 29. But in 2010, eligible taxpayers can also enter this amount on Schedule SE Line 3, thus reducing net earnings from self-employment subject to the 15.3 percent social security self-employment tax.
Premiums paid for health insurance covering the taxpayer, spouse and dependents generally qualify for this deduction. Premiums paid for coverage of an adult child under age 27 at the end of the year, for the time period beginning on or after March 30, 2010, also qualify for this deduction, even if the child is not the taxpayer’s dependent.
As before, the insurance plan must be set up under the taxpayer’s business, and the taxpayer cannot be eligible to participate in an employer-sponsored health plan. Details, including a worksheet, are in the instructions to Form 1040.
First-time homebuyer credit: You must meet the required deadlines to be eligible to claim the credit. You must have bought — or entered into a binding contract to buy — a principal residence on or before April 30, 2010. If you entered into a binding contract by April 30, 2010, you must have closed or gone to settlement on the home on or before Sept. 30, 2010. Because of the documentation requirements for claiming the credit, taxpayers who claim the credit on their 2010 tax return must file a paper — not electronic — return and attach Form 5405, First-Time Homebuyer Credit and Repayment of the Credit, and a properly executed copy of a settlement statement used to complete the purchase.
Taxpayers who claimed the first-time homebuyer credit for a home bought in 2008 must generally begin repaying it on the 2010 return. In most cases, the credit must be repaid over a 15-year period. Many of those affected by this requirement received reminder letters from the IRS.
A repayment requirement also applies to a taxpayer who claimed the credit on either their 2008 or 2009 return and then sold it or stopped using the home as their main home in 2010. Use Form 5405 to report the repayment.
In addition, certain members of the armed forces and some other taxpayers still have time to buy a home and take the credit. See Form 5405 and its instructions for details.
Standard Mileage Rates for 2010: The standard mileage rate for business use of a car, van, pick-up or panel truck is 50 cents for each mile driven. The rate for the cost of operating a vehicle for medical reasons or as part of a deductible move is 16.5 cents per mile. The rate for using a car to provide services to charitable organizations is set by law and remains at 14 cents a mile.
Tax Breaks Extended: Several tax breaks that expired at the end of 2009 were renewed and can be claimed on 2010 returns. They include:
• State and local general sales tax deduction, primarily benefiting people living in areas without state and local income taxes. Claim on Schedule A, Line 5.
• Higher education tuition and fees deduction benefiting parents and students. Claim on Form 8917.
• Educator expense deduction for kindergarten through grade 12 educators with out-of-pocket classroom expenses of up to $250, Claim on Form 1040, Line 23 or Form 1040A Line 16.
• District of Columbia first-time homebuyer credit. Claim on Form 8859
Important Tax Law Changes for 2010
The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, enacted on December 17, 2010, included several changes impacting workers’ take-home pay and retirees’ net pension checks for 2011. The Tax Relief Act extended for two years the income tax rates that were scheduled to expire at the end of 2010; that extension prevented a large increase in federal income tax withholding.
However, the new law did not extend the Making Work Pay (MWP) credit that had been available for tax years 2009 and 2010. While most workers qualified for the maximum MWP credit, pension recipients did not qualify for any MWP credit unless they also had wages or other earned income.
In December 2010, the IRS published new federal income tax withholding information to reflect the impact of the Tax Relief Act. The fact that that the MWP credit expired, by itself, would have resulted in increased withholding for most taxpayers. However, under the Tax Relief Act, withholding for social security tax for all wage earners was reduced from 6.2% to 4.2% (withholding for Medicare, at 1.45%, did not change). For most employees, the net effect of these two changes will result in less total tax being withheld from their checks. The social security tax reduction does not affect pension payments.
Due to the late enactment of these tax law changes, the IRS asked employers and plan administrators to adjust their systems as soon as possible but not later than January 31, 2011. This means employees and pension recipients may not have seen the full impact of these changes until their first paycheck in February, 2011.
Once employers implement the changes, there will be a net increase in take-home pay for most employees (excluding the impact of any other withholding amounts, such as withholding for health insurance, state income taxes, etc.).
Once pension plan administrators implement the 2011 changes, the retirement check payments for some pensioners may be lower depending upon the method that their plan administrators used to calculate withholding in 2010. Because the MWP credit did not apply to pensioners, the IRS published a table for 2009 and 2010 giving plan administrators the option of increasing withholding for their pension recipients. Not all plan administrators made the optional adjustment and instead allowed pensioners to make the adjustment when they filed their tax returns. Since the 2011 withholding tables do not reflect the expired credit, pension recipients in this situation are likely to see the withholding for their 2011 pension payments increase by approximately $7 to $50 per payment, depending on filing status, the amount of the payment, and how often the payment is made.