Apr. 18, 2011 is the due date for affected calendar year taxpayers to make their first installment of 2011 estimated tax. There aren't any changes in the estimated tax rules themselves for 2011. However, there are a number of new, changed and expiring provisions that will affect some individuals' estimated tax computations for 2011. This Practice Alert provides a brief overview of the estimated tax rules for individuals and looks at the changes that may impact 2011 estimated taxes.
Who needs to pay estimated tax. Individuals who have income that is not subject to withholding (for example, earnings from self-employment, interest, dividends, rents, alimony, etc.) must pay estimated tax or face a penalty. In addition, taxpayers who do not elect voluntary withholding on certain types of income, such as unemployment compensation and the taxable part of social security payments, also may have to pay estimated tax on those items or face a penalty. (Code Sec. 6654)
When and how much to pay. For 2011 estimated tax, in general, a taxpayer must pay 25% of a “required annual payment” by Apr. 18, 2011, June 15, 2011, Sept. 15, 2011 and Jan. 17, 2012 to avoid an underpayment penalty. (Code Sec. 6654(c))
The required annual payment for most taxpayers is the lower of 90% of the tax shown on the 2011 return or 100% of the tax shown on the 2010 return, even if filed late (“prior year exception”). However, a taxpayer (other than a farmer or fisherman) whose adjusted gross income on his 2010 return is over $150,000 (over $75,000 if married filing separately) must pay the lower of 90% of his 2011 tax or 110% of his 2010 tax. The prior year exception does not apply for a taxpayer who did not file a 2010 return or filed a 2010 return that did not cover 12 months. (Code Sec. 6654(d))
Other exceptions to penalty. There's no underpayment penalty if the tax shown on the return (after withholding) is less than $1,000. Estimated tax does not have to be paid for 2011 if the taxpayer was a U.S. citizen or resident alien for all of 2010 and had no tax liability for the full 12-month 2010 tax year. (Code Sec. 6654(e))
Annualized method. A taxpayer who, after Mar. 31, 2011, has a large change in income, deductions, additional taxes, or credits that requires him to start making estimated tax payments should use the annualized income installment method. While the due dates will not change, the payment amounts will vary based on the taxpayer's income, deductions, additional taxes, and credits for the months ending before each payment due date. As a result, this method may allow the taxpayer to skip or lower the amount due for one or more payments. A taxpayer who uses the annualized method should be sure to file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, with his 2011 tax return to indicate to IRS how he has computed his payments, even if no penalty is owed. (Code Sec. 6654(d)(2))
Farmers and fishermen. Special estimated tax rules apply to farmers and fishermen.
New items not reflected on Form 1040-ES. The Form 1040-ES instructions do not reflect these new law changes:
... Partial annuitization of nonqualified contracts. Under the “Small Business Jobs Act of 2010,” the tax title of H.R. 5297, the Small Business Lending Funding Act (P.L. 111-240), for amounts received in tax years beginning after Dec. 31, 2010, taxpayers may partially annuitize a nonqualified annuity, endowment, or life insurance contract. (Code Sec. 72(a)(2)) Thus, holders of nonqualified annuities can elect to receive a portion of an annuity contract in the form of a stream of annuity payments, leaving the remainder of the contract to accumulate income on a tax-deferred basis.
... Restricted definition of medicine for health plan reimbursements. Under Sec. 9003 of the Patient Protection and Affordable Care Act (PPACA, P.L. 111-148), the cost of over-the-counter medicines can't be reimbursed with excludible income through a health flexible spending arrangement (FSA), health reimbursement account (HRA), health savings account (HSA), or Archer MSA, unless the medicine is prescribed by a doctor. For HSAs and Archer MSAs, this applies for amounts paid with respect to tax years beginning after Dec. 31, 2010; for health FSAs and HRAs, it applies for expenses incurred with respect to tax years beginning after Dec. 31, 2010. (Code Sec. 106(f), Code Sec. 220(d)(2)(A), and Code Sec. 223(d)(2)(A))
... Boosted tax on nonqualifying HSA and Archer MSA distributions. Under PPACA Sec. 9004, for disbursements made during tax years starting after Dec. 31, 2010, the additional tax on distributions from an HSA that are not used for qualified medical expenses is increased from 10% to 20% of the disbursed amount, and the additional tax on distributions from an Archer MSA that are not used for qualified medical expenses is increased from 15% to 20% of the disbursed amount. (Code Sec. 220(f)(4)(A) and Code Sec. 223(f)(4)(A))
... Small employers may establish “simple cafeteria plans.” Under PPACA Sec. 9022, for years beginning after Dec. 31, 2010, small employers (average of 100 or fewer employees on business days during either of the two preceding years) may provide employees with a “simple cafeteria plan.” (Code Sec. 125(j)) Under such a plan, the employer is provided with a safe harbor from the nondiscrimination requirements for cafeteria plans as well as from the nondiscrimination requirements for specified qualified benefits offered under a cafeteria plan, including group term life insurance, benefits under a self-insured medical expense reimbursement plan, and benefits under a dependent care assistance program.
... Up-to-$1,000 credit for “retained workers” in 2011. For any tax year ending after Mar. 18, 2010, Sec. 102 of the Hiring Incentives to Restore Employment Act (HIRE Act, P.L. 111-147) provides an up-to-$1,000 increase (retention credit) to the general business credit for “retained workers.”
... New basis and character reporting rules. Under the Emergency Economic Stabilization Act of 2008 (EESA, P.L. 110-343), generally effective on Jan. 1, 2011, every broker required to file an information return reporting the gross proceeds of a “covered security” must include in the return the customer's adjusted basis in the security and whether any gain or loss with respect to the security is short term or long term under Code Sec. 1222. (Code Sec. 6045(g))
... Designated Roth accounts in Section 457 plans. Under the Small Business Jobs Act of 2010 (P.L. 111-240), for tax years beginning after Dec. 31, 2010, governmental Section 457 plans (i.e., Code Sec. 457(b) eligible deferred compensation plans of a Code Sec. 457(e)(1)(A) eligible employer) are added to the definition of “applicable retirement plans” that can offer a qualified Roth contribution program. (Code Sec. 402A(e)(1)(C)) Thus, a Section 457 plan maintained by a state, its political subdivision, agency, or instrumentality, or the state subdivision's agency or instrumentality, can include a qualified Roth contribution program.
... Reporting requirement for payment card and third-party payment transactions. The Housing Assistance Tax Act of 2008, Div. C. of P.L. 110-289, added Code Sec. 6050W. After 2010, it generally requires banks to file an information return with IRS reporting the gross amount of credit and debit card payments a merchant receives during the year, along with the merchant's name, address, and taxpayer identification number (TIN). Similar reporting is also required for third-party network transactions (e.g., those facilitating online sales).
... Information reporting for real estate. Under the Small Business Jobs Act of 2010, for payments made after Dec. 31, 2010, subject to exceptions, solely for purposes of Code Sec. 6041(a) information reporting, a person receiving rental income from real estate is considered to be engaged in a trade or business of renting property. (Code Sec. 6041(h)(1)) Thus, recipients of rental income from real estate generally are subject to the same information reporting requirements as taxpayers engaged in a trade or business. In particular, rental income recipients making payments of $600 or more during the tax year to a service provider (such as a plumber, painter, or accountant) in the course of earning rental income are required to provide an information return (typically Form 1099-MISC) to IRS and to the service provider.
New items reflected on Form 1040-ES. A taxpayer should use his 2010 return as a starting point for figuring his 2011 estimated tax. He should determine whether he will benefit by any of the following new provisions:
... Temporary decrease in payroll tax. For 2011, social security tax is withheld from an employee's wages at the rate of 4.2% (down from 6.2%) up to the social security wage limit of $106,800. There is no change to Medicare withholding. The same reduction applies to net earnings from self-employment—the temporary rate is 10.4% (down from 12.4%) up to the social security wage limit of $106,800. The method of figuring “one-half of self-employment tax” for adjusted gross income has changed slightly, and a worksheet is provided in the Form 1040-ES instructions.
... Qualified charitable distribution (QCD). Tax-free treatment of distributions from traditional and Roth IRAs for charitable purposes has been extended through Dec. 31, 2011, with the following special rule. For QCDs made during January 2011, the taxpayer can elect to have the distribution deemed to have been made on Dec. 31, 2010. If this election is made, the QCD counts toward the taxpayer's 2010 exclusion limit of $100,000, as well as his 2010 minimum required distribution.
... Nonbusiness energy property credit. This credit has been extended for 1 year with a reduced rate of 10%. Amounts provided by subsidized federal, state, or local energy financing do not qualify for the credit. The energy-efficiency standards for qualified natural gas, propane, or oil furnaces, or hot water boilers have been increased. For 2011, the credit is limited as follows.
• ... A total combined credit limit of $500 for all tax years after 2005 (Form 5695, Part I).
• ... A combined credit limit of $200 for windows for all tax years after 2005.
• ... A maximum credit for residential energy property costs of $50 for any advanced main air circulating fan; $150 for any qualified natural gas, propane, or oil furnace or hot water boiler; and $300 for any item of energy-efficient building property.
... Increase in additional tax on certain distributions not used for qualified medical expenses. The tax on distributions from HSAs and Archer MSAs made after Dec. 31, 2010, that are not used for qualified medical expenses, is increased to 20%.
... Roth IRAs. If the taxpayer rolled over or converted part or all of another retirement plan to a Roth IRA in 2010, or made an in-plan rollover to a designated Roth account after Sept. 27, 2010, and did not elect to include the resulting taxable amount in income for 2010, he must report half of that taxable amount on his 2011 return and the other half on his 2012 return.
Changed provisions. In calculating 2011 estimated tax, individuals also should consider the following changed provisions:
... Alternative minimum tax (AMT) exemption amount increased. The AMT exemption amount is increased to $48,450 ($74,450 if married filing jointly or a qualifying widow(er); $37,225 if married filing separately).
... Increased standard deductions. The basic and additional standard deduction amounts have increased for most categories of taxpayers for 2011.
... Standard mileage rates. The rate for business use of a vehicle is increased to 51 cents a mile. The rate for use of a vehicle to get medical care or move is increased to 19 cents a mile. The rate of 14 cents a mile for charitable use is unchanged.
... Personal exemption increased. For tax years beginning in 2011, the personal exemption amount is increased to $3,700.
... Income limits for excluding education savings bond interest increased. In order to exclude interest, the taxpayer's modified adjusted gross income (MAGI) must be less than $86,100 ($136,650 if married filing jointly or a qualifying widow(er)).
... Lifetime learning credit income limits increased. In order to claim a lifetime learning credit, the taxpayer's MAGI must be less than $61,000 ($122,000 if married filing jointly).
... Retirement savings contribution credit income limits increased. In order to claim this credit, the taxpayer's MAGI must be less than $28,250 ($56,500 if married filing jointly; $42,375 if head of household).
... Adoption credit or exclusion. The maximum adoption credit or exclusion for employer-provided adoption benefits has increased to $13,360. In order to claim either the credit or exclusion, the taxpayer's MAGI must be less than $225,210.
... Qualified fuel cell motor vehicle credit reduced. For qualified vehicles with a gross vehicle weight rating of 8,500 pounds or less that are placed in service after 2009, the credit allowed for the purchase is reduced by 50%.
... Earned income credit. The maximum credit, the maximum AGI a taxpayer can have and still get the credit, and the maximum investment income a taxpayer can have and still get the credit, are higher.
... Foreign earned income exclusion. The maximum exclusion has increased to $92,900.
... Health coverage tax credit (HCTC). Beginning after Feb. 12, 2011, the credit has decreased to 65% (from 80%) for amounts paid for qualified health insurance coverage for the taxpayer, his spouse, and other qualifying family members.
Expired tax benefits. The following tax items are scheduled to expire or have been repealed and are not available for 2011:
... Making work pay credit.
... Self-employed health insurance deduction when figuring self-employment tax.
... Exclusion from income of benefits provided to volunteer firefighters and emergency medical responders.
... Computer technology and equipment allowed as qualified higher education expenses for qualified tuition programs (section 529 plans).
... Exemption from alternative minimum tax treatment for certain tax-exempt bonds.
... Advance earned income credit.