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What the New Tax Law Means for Federal Employees
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.
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.