Tax Law’s Impact

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OCEAN CITY – The $858 billion tax law enacted in December – formally known as the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the "Act") – promises to affect Americans of all income levels. But while it largely keeps rates steady for the next two years, it also includes some major changes that have taken many taxpayers by surprise.

The answers to these six questions will help you make the most of the opportunities arising from the new Act as you prepare for 2011 and beyond. This week we examine the first two questions.

How will my take-home income be affected?

The Bush-era federal income tax rates have been extended through 2012. The top rate, which would have risen to 39.6%, will stand at 35%, and long-term capital gains and qualified dividends will continue to be taxed at 15%. In addition, the Act gives the vast majority of workers a two percentage point reduction in Social Security payroll tax for 2011, which means that, as an employee, you’ll pay only 4.2% on the first $106,800 of your paycheck, instead of 6.2%.

"That rebate is a big deal," says Andrew Friedman, a tax policy expert and principal of the Washington Update, a website that offers up-to-the-minute insights on government policies that affect finances, taxes and investment. "People making more than $100,000 are going to save around $2,000 on Social Security payroll taxes alone."

How has the estate tax been altered?

Although the estate tax was suspended for 2010, it was scheduled to revert back to the pre-Bush era rate of 55% with a $1 million limit on the amount individuals could pass onto their heirs tax-free. The Act raises that exemption to $5 million, and instates a 35% estate tax rate. Perhaps even more surprising, the Act does something similar for the gift tax, raising the lifetime gift tax exemption from $1 million to $5 million as well. That means a couple can now give their children up to $10 million tax-free.

"Admittedly, that’s going to affect a small number of people, but you don’t have to have $10 million to take advantage of these changes," says Scott Cooper, Managing Director of Merrill Lynch’s Wealth Structuring Group. "Even if you planned on gifting less, you could still save thousands of dollars in taxes by gifting the money this year or next over what you would have paid before."

Cooper advises working with your financial advisor to run the numbers and figure out how much you can gift or put in trust over the next two years without jeopardizing your lifestyle or retirement.

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)

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