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What the New Tax Law Means for Federal Employees
Edward A. Zurndorfer, Certified Financial Planner
As a result of the passage of the Tax Relief, Unemployment Insurance
Reauthorization, and Job Creation Act of 2010, federal employees -- including
those employees whose total annual taxable income is $250,000 and over -- will
not have to worry about paying more in taxes in 2011 than they did in 2010 if
their taxable income does not change during 2011.
This column summarizes the changes in the new tax and how they will affect
federal employees, effective Jan. 1, 2011.
Cut in Social Security payroll (FICA) taxes.
The new law will decrease the Social Security payroll (Federal Insurance
Contributions Act or FICA) tax from 6.2 percent to 4.2 percent during 2011. The
payroll tax cut will reduce taxes by $120 billion for 155 million workers,
including most federal employees. FERS and CSRS Offset employees will be
affected by the FICA tax cut because each pay date those employees pay the FICA
tax up to the maximum $106,800 of wages earned during 2011. Once an employee's
wages reaches $106,800, there will be no FICA taxes withheld from the employee's
wages until the first date in January 2012. CSRS employees will not receive any
payroll tax cut because CSRS employees do not pay into Social Security. These
employees will continue to contribute seven percent of their after-taxed wages
into the CSRS Retirement and Disability Fund.
Provision to allow individuals to deduct state and local sales taxes.
This provision -- which has been available to individual taxpayers since 2004
and was due to expire Dec. 31, 2010 - gives individual taxpayers who itemize
(file Schedule A) the option of deducting state and local sales taxes instead of
state income taxes. The provision benefits those individuals - including many
federal employees - who live in the seven states that impose no state income
taxes but impose state sales taxes on their residents. These states include
Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming.
A tax credit for individuals who make energy-efficient improvements
to their homes.
While this credit is less generous for homeowners who make energy
improvements during 2011 compared to the energy-efficient tax credits available
during 2009 and 2010, there are some tax credits available to individual
homeowners during 2011. In particular, there is a 10 percent credit -- up to
specific maximum amounts -- if an individual homeowner installs insulation or
energy-efficient windows or roofs. Individuals will also be eligible for credits
ranging from $50 to $150 for purchases of energy-efficient fans, water heaters
and furnaces.
Mortgage insurance deduction available through 2011
Most homebuyers who make a down payment of less than 20 percent of the home
purchase price are required to pay mortgage insurance. The mortgage insurance is
designed to protect lenders from default. For 2011 - as was true during 2010 -
those homeowners who pay mortgage insurance will be able to deduct their
mortgage insurance as an itemized deduction on Schedule A.
Child tax credit extension
The child credit allows eligible families to use a tax credit up to $1,000
for each qualifying child under the age of 17. As a tax credit, the child tax
credit reduces one's tax liability "dollar for dollar". While there are adjusted
gross income (AGI) limits for using this credit, most federal employees with
young families should be eligible to use most, if not all, of this tax
credit.
Extension of several tax credits designed to reduce the cost of
higher education
The American Opportunity Credit, which is designed to offset the cost of
attending a college or university, is extended through 2012. This credit
provides a tax credit of up to $2,500 per college student per year. Individuals
can claim the credit for up to 100 percent of the first $2,000 in qualified
college costs and 25 percent of the next $2,000. 40 percent of the credit is
refundable; as such, an eligible low income family who does not owe federal
taxes can still receive a check from the IRS for up to $1,000 by virtue of the
fact that they have a child or children attending a college or university. In
addition, the AGI limits on this credit are broader than limits on the Hope and
Lifetime Learning credits. Married couples with AGI's of up to $160,000 can
claim the full credit. For federal employees who have children attending
colleges and universities, each of these credits can help lower the cost of
higher education.
Coverdell Education Savings Accounts (CESAs) are
extended
The 2010 tax law allows individuals to contribute a maximum $2,000 a year to
these tax-advantaged accounts through Dec. 31, 2012. Without the extension, the
maximum annual contribution to CESAs would have decreased to $500. All
contributions made to a CESA are made with after-taxed dollars. But all
withdrawals from CESAs - including accrued earnings - are tax-free provided the
withdrawals are used to pay for nursery school, elementary and secondary
private/parochial school expenses, and higher education (college and vocational
school) expenses. A CESA can assist federal employees with children attending
nursery school, private and parochial school, elementary and secondary school as
well as a post-high school educational institution.
Student loan interest deduction
A provision in the new law allows student loan borrowers to deduct up to
$2,500 in interest paid on student loans through Dec. 31, 2012. Without the
extension, the deduction would have still been available but with lower AGI
limits for eligible borrowers. For those new federal employees who recently
graduated from college or university and who are paying back student loans, this
provision can result in tax savings.
No increase in capital gains tax rates
The top tax rate for long-term (at least one year) capital gains and
dividends will remain at 15 percent for individuals in the 25 percent and
marginal tax bracket, and zero percent for individuals in the 10 percent and 15
percent tax brackets until Dec. 31, 2012. If the tax cuts had been allowed to
expire, the top rate for long-term capital gains would have risen to 20 percent
in 2011. The top rate for dividends would have risen to the investor's ordinary
income tax rate - up to 35 percent for the wealthiest individual taxpayers. For
federal employees who invest in stocks and stock mutual funds in a
non-retirement account, this is good news. They will continue to see their
investment income taxed at "preferential" rates rather than at "ordinary" income
tax rates - at which their salaries and interest income is taxed.
Alternative Minimum Tax (AMT) relief
The new tax law has a stopgap measure that will prevent the AMT from
spreading to many middle-class individual taxpayers. Without the stopgap
measure, up to 25 million taxpayers would have been subject to the AMT in 2010,
up from 3.9 million in 2009 according to an analysis by H&R Block. Many
federal employees would have been subject to the AMT without this AMT stopgap
measure.
Extension of personal exemption limitation repeal
The new tax law extends through Dec. 31, 2012 the repeal of a provision that
limits the amount of personal exemptions high-income individual taxpayers could
claim. Without this agreement, many higher income federal employees - those
employees with AGIs over $150,000 - would have been limited for 2011 and 2012
the number of personal exemptions they could claim on their income taxes.
Finally, the IRS announced in early January that while the tax season will
start on time for most individual taxpayers, some individual taxpayers will need
to wait until mid-to-late February to file their income taxes. In particular,
those individuals claiming any of the following three items as deductions - the
state and local sales tax deduction, higher education and fees deduction, and
the educator expense deduction, as well as those individuals who itemize
deductions on Form 1040 Schedule A, are strongly encouraged to wait to file
their tax returns. The reason is that the tax law changes enacted by Congress
and signed by President Obama in late December has given the IRS little time to
reprogram its processing system.
The IRS also urged individuals to use e-file instead of paper tax forms in
order to minimize confusion over recent tax law changes and to ensure accurate
tax returns. The filing deadline for 2010 income taxes is April 18, 2011. While
April 15 - this year April 15, 2011 is a Friday - is normally the tax filing
deadline, April 15, 2011 is Emancipation Day in the District of Columbia. By
law, District of Columbia holidays impact tax deadlines in the same way that
federal holidays do. The IRS therefore extended the filing deadline to the next
business day, Monday April 18, 2011.
Posted: 1/18/11
About the Author
Edward A. Zurndorfer is a Certified Financial Planner, Registered Health
Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in
Silver Spring, MD and the owner of EZ Accounting and Financial Services, an
accounting, tax preparation and financial planning firm also located in Silver
Spring, MD. He is an instructor at federal employee retirement
seminars throughout the country and writes numerous columns and books on federal
employee benefits.
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