Erin Schlichting

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The IRS and Treasury have issued long-awaited, comprehensive regulations on the capitalization of amounts paid to acquire, produce or improve tangible property. The regulations, released at the end of 2011 and effective immediately for most taxpayers, provide the standards that businesses must now apply to determine whether expenditures can be deducted as repairs or must be capitalized and then recovered over a period of years.

 

The regulations are broad and far-reaching – they apply to every business taxpayer that uses tangible property, whether owned or leased, regardless of the form of entity that operates the business, and regardless of the entity’s foreign or domestic status. They apply to manufacturers, wholesalers, distributors, and retailers.

 

The new regulations have taken effect and steps must be taken to comply with them. They generally apply to amounts paid or incurred in tax years beginning on or after January 1, 2012. Thus, for calendar year taxpayers, the rules already apply. Some of the rules build upon rules already in place; other requirements, however, are completely new. The IRS will take comments and consider further changes, so any plans set forth to respond to these new regulations must themselves be ready for fine tuning.

 

The regulations are generally beneficial to most businesses, but they also add complexity. They provide a more defined framework for determining capital expenditures, along with some clarifications of the law and some simplifying conventions. The regulations make significant and substantial changes to the previous proposed regulations issued by the government in 2008. In many cases, the tax treatment of an expenditure will vary from its treatment for book purposes, putting an additional burden on taxpayers to apply new tax accounting systems to track and collect data.

 

The regulations will require many decisions by taxpayers in determining the appropriate tax treatment. In some cases, taxpayers are given an explicit election to decide what type of tax treatment to follow. In other cases, taxpayers must make a de facto election. In either case, once the taxpayer adopts a particular method of accounting for particular assets, that business must continue to follow that method of accounting, and will not be able to change it without the IRS’s permission.

 

There will be more guidance from the IRS. Most taxpayers will need to change their method of accounting to comply with the new regulations. The IRS has promised to issue revenue procedures that provide transition rules for taxpayers changing their method of accounting. The regulations require that taxpayers make so-called Code Section 481(a) adjustments to prevent duplicated or omitted tax benefits. Because of this requirement, taxpayers will in effect have to apply the new rules to costs incurred prior to the effective date of the regulations. As a result, some taxpayers may have to capitalize amounts they previously deducted, and recognize income based on the difference in treatment. Conversely, other taxpayers may be able to deduct amounts previously capitalized, and take a deduction for the difference.



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By Danielle Kurtzleben from US News

December 20, 2011 RSS Feed Print

Caring about an issue and knowing about it can be two completely different things. Many Americans have strong views on how to fix the nation’s ever-growing deficits and debts. But there are gaps in what, exactly, voters know about the subject. A new poll shows that many Americans lack basic knowledge on the nation’s fiscal situation.

Americans are relatively knowledgeable on a few key points but uninformed on others, according to the National Fiscal IQ poll by the Comeback America Initiative, a nonpartisan organization that seeks to promote fiscal responsibility. The poll of 1,000 registered voters shows that a significant majority—62 percent—understand that U.S. debt as a percentage of GDP rivals or exceeds that of several troubled European nations (margin of error of 3.1 percent). And 73 percent understand that government healthcare programs are not financially sustainable. As the Congressional Budget Office reported earlier this year, spending growth in these programs cannot continue at its current rate indefinitely.

[Want to test your fiscal IQ? Visit fiscaliq.net.]

However, respondents were less well-informed about how they personally relate to the federal deficit. Sixty-eight percent of respondents believe that most individuals pay more in payroll taxes and medicare premiums than they end up receiving from Social Security and Medicare—a statement that is false. And a plurality of respondents, 49 percent, believe that U.S. taxation is above-average compared to other industrialized nations—also a false statement.

“There’s been a lot of disinformation and misinformation,” says David Walker, former U.S. comptroller general and the founder of the Comeback America Initiative. “Leaders are supposed to educate people as to the facts, truth, and help make tough choices. … While we’ve had a lot of these national [bipartisan deficit-reduction] commissions, none of them have done any meaningful work to try to educate the American people about the issues that they’re going to have to understand and accept in order for the officials to make these tough choices.”

Walker believes the problem is widespread, with both major political parties, individuals, and special-interest groups all contributing to these misperceptions.

Of course, the news media is how people receive this information, and coverage that does not explore issues in-depth also helps to explain Americans’ lack of knowledge on some issues.

“The media’s not very good at explaining details. The media is good at talking about game stuff—’will we pass or not pass X,’ not ‘what’s the meat of this about?'” says Kimberly Gross, associate professor of media and public affairs at George Washington University. For example, she says, many Americans may not understand the complicated benefits and funding structures of entitlement programs like Social Security or Medicaid.

A media that closely monitors politicians’ every move means that politicians can often set the agenda for what messages are broadcast, promoting particular narratives—sometimes not entirely factually based—to broad swaths of the public. “Partisans have an investment in telling certain stories,” says Gross. For example, she says, “Democrats might say, ‘We don’t need to cut entitlements, and we can tax the rich.’ … Republicans might say, ‘If we just lower taxes, more money really will come in.'”



Erin Schlichting

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On August 2, 2011, President Obama signed the 2011 Budget Control Act (P.L. 112-25). The Budget Control Act cuts approximately $1 trillion in federal spending, raises the federal debt ceiling and creates a bipartisan joint committee of Congress to weigh additional deficit reduction measures. This article describes the work of the joint committee, its short timeline for making recommendations, some tax measures the joint committee may consider, and possible effects on tax planning.

Joint committee. The Joint Select Committee on Deficit Reduction, as the joint committee is officially known, is charged with the goal of reducing the federal government deficit by at least $1.5 trillion over 10 years. How the joint committee will achieve that goal remains to be seen. Some lawmakers want the joint committee to focus solely on spending cuts; other lawmakers want the joint committee to recommend a mix of spending cuts and tax increases. President Obama has repeatedly called for a “balanced” approach.

The 12-member joint committee is evenly split between Democrats and Republicans (six lawmakers from each party). The even split has some Washington observers predicting that the joint committee will ultimately deadlock and reach no agreement or the lawmakers will compromise and reach an agreement that could include spending cuts and revenue raisers. If the joint committee does not make any recommendations and submit legislative language or if Congress fails to act on the recommendations and legislative language, the Budget Control Act provides for automatic spending cuts.

Timeline. The Budget Control Act sets out a timeline for the joint committee to report to Congress.

  1. Not later than 14 days after enactment of the Budget Control Act, the Democratic and Republican leaders in the House and Senate shall appoint the members of the joint committee (three Democrats from the House, three Democrats from the Senate, three Republicans from the House and three Republicans from the Senate).
  2. Not later than 45 days after enactment of the Budget Control Act, the joint committee shall hold its first meeting.
  3. Not later than October 14, 2011, House and Senate committees may transmit to the joint committee their recommendations for deficit reduction.
  4. Not later than November 23, 2011, the joint committee shall vote on a detailed report that contains the findings, conclusions and recommendations of the committee and proposed legislative language to carry out those recommendations. The Budget Control Act requires seven members of the joint committee to agree on its final recommendations and legislative language.
  5. Not later than December 23, 2011, Congress shall vote on the joint committee’s recommendations and legislative language.

Taxes. Potentially, the joint committee has a host of tax measures to consider.

Late in 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act (2010 Tax Relief Act), which extended reduced individual income tax and capital gains/dividends tax rates through the end of 2012. The 2010 Tax Relief Act also provided for temporary extensions of marriage penalty relief, temporary enhancements to the child tax credit and earned income credit, and temporary repeal of the limitation on itemized deductions and personal exemption phaseout for higher income taxpayers. Additionally, the 2010 Tax Relief Act provided for temporary estate tax reform and alternative minimum tax (AMT) relief.

Many popular but temporary tax incentives, known as extenders, are also set to expire after 2011. These extenders include, but are not limited to, the research tax credit, special depreciation rules for qualified leasehold, restaurant and retail improvement property, the Indian employment credit, and expensing of environmental cleanup costs. Additionally, current provisions for 100 percent first-year bonus depreciation and enhanced Code Sec. 179 small business expensing are also temporary.

The joint committee could also consider corporate and international tax reform. The U.S. corporate tax rate is the second highest in the industrialized world and the White House previously signaled its openness to reducing it in exchange for the closing of unspecified business tax loopholes. President Obama also has proposed some international tax reforms. Lawmakers from both parties have supported a temporary repatriation tax holiday for overseas profits of multinational companies.

Additional tax measures the joint committee could consider include (but not limited to):

  1. Change in the tax treatment of so-called carried interest;
  2. Repeal of the last-in/first-out (LIFO) method of accounting;
  3. Repeal of tax preferences for oil and gas production;
  4. Reform or elimination of the AMT; and
  5. Reform or repeal some of the tax provisions in the Patient Protection and Affordable Care Act (PPACA).

The joint committee may also build on previous tax reform proposals. In 2010, the President’s National Commission on Fiscal Responsibility and Reform developed a six-part plan to reduce the federal deficit. The commission recommended reducing or eliminating many tax incentives for individuals in exchange for lower individual income tax rates. The commission also endorsed lowering the corporate tax rate to 26 percent. In July 2011, a bipartisan group of senators, known as the “gang of six,” introduced a plan for deficit reduction. The senators’ plan would, among other provisions, replace the current individual income tax rate schedule with three new tax brackets along with abolishing the AMT.

Tax planning. Uncertainty about federal tax legislation in the past few years has contributed to uncertainty in tax planning. This year is no exception.

During negotiations over the Budget Control Act, President Obama often repeated his opposition to extending the Bush-era tax cuts for higher income taxpayers after 2012. The White House generally defines higher income taxpayers as individuals with incomes over $200,000 and families with incomes over $250,000. After the Budget Control Act became law, several White House officials predicted that President Obama will veto any bill that extends the Bush-era tax cuts for higher income taxpayers after 2012. Many Washington observers see President Obama’s veto threat as intended to encourage the joint committee to compromise on extending the Bush-era tax cuts for lower and middle income taxpayers but allowing the Bush-era tax cuts to expire for higher income taxpayers.

If the joint committee cannot agree on recommendations and legislative language, Congress could take up some expiring tax measures in separate bills. Congress could, as in past years, extend the research tax credit and other extenders, AMT relief and additional expiring provisions, in stand-alone legislation or attached to other bills. Larger tax measures, such as the Bush-era tax cuts, may wait until after the 2012 presidential election.



Erin Schlichting

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Currently, the likelihood of your business being involved in a worker classification or employment tax audit is increased because the IRS is aggressively attempting to reduce the “tax gap,” which is the annual shortfall between taxes owed and taxes paid. Employment tax noncompliance is estimated by the IRS to account for approximately $54 billion of the tax gap. Under-reporting of FICA makes up $14 billion; under-reporting of self-employment tax accounts for $39 billion; and under-reporting of unemployment tax accounts for $1 billion in lost revenue.

As a result of the Questionable Employment Tax Practice (QETP) initiative, in 2007 the IRS entered into agreements with workforce agencies in 29 states to share the results of employment tax examinations. These agreements provide a centralized, uniform means for the IRS and state employment officials to encourage compliance with federal and state employment tax requirements. In addition, for the 2008 through 2010 tax years, the IRS plans to examine 6000 randomly selected employers’ Forms 941, Employer’s Quarterly Federal Tax Return, as part of the National Research Program (NRP).

Because the existing worker classification rules are complex and ambiguous, much uncertainty surrounds their interpretation and application. The lack of a single, definitive test for classifying workers as either employees or independent contractors contributes significantly to the worker classification problem.

Therefore, understanding the difference between an employee and an independent contractor is very important. If you are an employer, you are required to withhold and contribute a matching amount of FICA and Medicare taxes from your employee’s income. However, if your workers are independent contractors, you are only required to report payments of $600 or more on a Form 1099-MISC (Miscellaneous Income). Failing to make the right classification could cost you money.

If you have workers who make substantial financial investments in tools, equipment, or a place to work, or undertake some entrepreneurial risks, they are probably independent contractors. However, when you control and direct the workers who perform services for you as to the end result and how it will be accomplished, you are probably involved in an employer-employee relationship.

Unless there is a reasonable basis for treating your employees as independent contractors, failing to withhold income and employment taxes from their wages can result in severe penalties and interest, in addition to the back taxes owed. Of course, penalties for intentional worker misclassifications are harsher than they are for inadvertent mistakes.

Your benefit plan may also be in jeopardy if any eligible employees have been misclassified as independent contractors. Since these employees have been excluded from plan participation, your retirement plan may lose its tax-favored status. The problem is compounded when excluded employees seek restitution for lost benefits not only due to their exclusion from the benefit plan, but also for health coverage and other employee benefits.

Since the potential liability is considerable, we feel that it would be beneficial for you to verify that your workers are properly classified. It is also important that your employment tax records are in compliance with IRS guidelines, especially in the event of an audit.



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Now may be a good time to evaluate the expenses you incur as an employee in connection with your work. While your employer may be reimbursing you for some of these expenses, there may be others for which you are bearing the cost yet not utilizing the tax benefit. Through proper substantiation, it is possible that you may be able to obtain greater reimbursement from your employer. Alternatively, you may be entitled to deduct such expenses as miscellaneous itemized deductions.

In order to be reimbursed and/or deducted, trade or business expenses must be ordinary, necessary, and reasonable. They also must be properly substantiated. Examples of qualifying expenses include:

  • Travel, transportation, meal, or entertainment expenses
  • Safety equipment, small tools, or supplies
  • Uniforms required by your employer that are not suitable for everyday wear
  • Required protective clothing
  • Dues to professional organizations
  • Subscriptions to professional journals
  • Certain job hunting expenses
  • Certain expenses for the business use of your home
  • Computer costs
  • Work-related educational expenses

You may also benefit from a review of the business expenses related to the use of your home. If you qualify for the home office deduction, you may be able to deduct part of your home’s normal operating expenses, such as utilities and insurance. The tax-savings opportunities available to you are dependent not only on the type of work you do at home, but where in your home you perform it.



Erin Schlichting

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Two new laws

Health care reform is actually made up of two new laws: the Patient Protection and Affordable Care Act of 2010 and the Health Care and Education Reconciliation Act of 2010. The Patient Protection Act was crafted largely in the Senate and sets out the general framework of health care reform. The Reconciliation Act was prepared in the House to modify the Patient Protection Act, especially in the areas of tax credits and cost sharing for individuals to help make coverage more affordable. Common features to both laws are delayed effective dates for many of the provisions, which make strategic planning all that more important.

New taxes and penalties

Viewing the historic health care reform package from the context of the Tax Code, many new taxes and penalties stand out immediately above the rest. Initially, we would advise taking particular note of the following highlights:

* Individuals who earn more than $200,000 for the year ($250,000 for married couples) will be paying an additional 0.9 percent in Hospital Insurance (Medicare) tax, starting in 2013;

* Individuals whose adjusted gross income for the year exceeds $200,000 ($250,000 for joint filers), whether from wages or otherwise, will also be paying an additional 3.8 percent Medicare tax on net investment income, starting in 2013;

* Employers with 50 or more employees generally will be required to provide a minimum level of health insurance for their employees or pay a penalty per employee, starting in 2014;

* Small employers with no more than 25 employees are entitled to up to a 35 percent tax credit on the cost of providing health insurance for employees, starting immediately in 2010;

* Most individuals will be required to obtain health insurance or be subject to a penalty tax starting in 2014;

* Tax credits to subsidize the cost of health insurance premiums will be available to individuals earning up to 400 percent of the poverty level, starting in 2014;

* Health flexible savings arrangement (FSA) dollars will be limited to prescription medications with some exceptions after 2010, along with placing a $2,500 annual cap on expenses covered under health FSAs, starting in 2013;

* A 40 percent excise tax will be imposed on high-cost, “Cadillac” employer-sponsored health coverage, starting in 2018;

* Fees will be imposed on the pharmaceutical industry and health insurance providers , starting in 2011 and 2014, respectively;

* An excise tax will be imposed on medical device manufacturers after 2012; and

* Limits on tax-subsidized medical expenses will be imposed by raising the itemized medical expense deduction floor for regular tax purposes from 7.5 percent to 10 percent, generally starting in 2013.

Tax incentives

Among a handful of tax incentives provided under the new health-care reform package, two are particularly notable at this time: (1) the ability of parents to cover adult children up to age 27 under their tax-qualified employer-provided health plans, starting immediately on or after March 23, 2010; and (2) the unveiling of a simplified cafeteria plan specifically tailored to small businesses, starting in 2011.

Exchanges

The health care reform package requires each state to establish an exchange by 2014 to help individuals and qualified  employers obtain coverage. Coverage will be offered at various levels. Qualified individuals may be eligible for premium assistance tax credits, cost-sharing or vouchers to help pay for coverage through an insurance exchange. An individual’s income whether or not coverage is provided by his or her employer will all be taken into account when determining if the individual
qualifies for a premium assistance tax credit, cost-sharing or voucher.

IRS guidance

Over the course of the next few months, the IRS and other federal agencies will be filling in details on how to comply with all the provisions under the massive health care reform package. The IRS is expected to issue guidance soon on the provisions with effective dates in 2010 and 2011.



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After weeks of intense negotiations between the White House and Congressional leaders, Congress passed and President Obama signed into law a two-year extension of soon-to-have-expired  Bush-era tax cuts, including extension of current individual tax rates and capital gains/dividend tax rates. Called the most sweeping tax law in a decade, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (H.R. 4853), was approved by the Senate on December 15, 2010 and by the House on December 16, 2010.  The new law is, however, much more than just an extension of existing tax rates. The new law also provides a temporary across-the-board payroll tax cut for wage earners, a retroactive AMT “patch,” estate tax relief, education and energy incentives and many valuable incentives for businesses, including 100 percent bonus depreciation and extension of many temporary tax breaks. This letter highlights many of the key incentives in the new law.

Individuals

Tax rates. Among the most valuable tax breaks for individuals in the new law are a two-year extension of individual income tax rate reductions and a payroll tax cut.  Both will deliver immediate tax savings starting in January 2011.  The new law keeps in place the current 10, 15, 25, 28, 33, and 35 percent individual tax rates for two years, through December 31, 2012. If Congress had not passed this extension, the individual tax rates would have jumped significantly for all income levels.  The new law also extends full repeal of the limitation on itemized deductions and the personal exemption phaseout for two years. Married couples filing jointly will also benefit from extended provisions designed to ameliorate the so-called marriage penalty.

Payroll tax cut. The payroll tax cut is designed to get more money into workers’ paychecks and to encourage consumer spending. Effective for calendar year 2011, the employee share of the OASDI portion of Social Security taxes is reduced from 6.2 percent to 4.2 percent up to the taxable wage base of $106,800. Self-employed individuals also benefit. Self-employed individuals will pay 10.4 percent on self-employment income up to the wage base (reduced from the normal 2.4 percent rate).  The payroll cut replaces the Making Work Pay credit, which reduced income tax withholding for wage earners in 2009 and 2010. The payroll tax cut, unlike the credit, does not exclude some individuals based on their earnings and has the potential of significantly higher benefits (with a maximum payroll tax reduction of $2,136 on wages at or above the $106,800 level as compared to a maximum available $800 Making Work Pay credit for married couples filing jointly ($400 for single individuals)).

Capital gains/dividends. The new law also extends reduced capital gains and dividend tax rates.  Like the individual rate cuts, the extended capital gains and dividend tax rates are temporary and will expire after 2012 unless Congress intervenes.  In the meantime, however, for two years (2011 and 2012), individuals in the 10 and 15 percent rate brackets can take advantage of a zero percent capital gains and dividend tax rate.  Individuals in higher rate brackets will enjoy a maximum tax rate of 15 percent on capital gains, as opposed to a 20 percent rate that had been scheduled to replace it and with dividends taxed at income tax rates.  Only net capital gains and qualified dividends are eligible for this special tax treatment.

AMT patch. More and more individuals are finding themselves falling under the alternative minimum tax (AMT) because of the way the AMT is structured. To prevent the AMT fromthis trend by providing higher exemption amounts and other targeted
relief.

More incentives. Along with all these incentives, the new law extends many popular but temporary tax breaks. Extended for 2011 and 2012 are:

  • $1,000 child tax credit
  • Enhanced earned income tax credit
  • Adoption credit with modifications
  • Dependent care  credit
  • Deduction for certain mortgage insurance premiums
The new law also extends retroactively some other valuable tax incentives for individuals that expired at the end of 2009. These incentives are extended for 2010 and 2011 and include:
  • State and local sales tax deduction
  • Teacher’s classroom expense deduction
  • Charitable contributions of IRA proceeds
  • Charitable contributions of appreciated property for conservation purposes

Businesses

Bonus depreciation. Bonus depreciation is intended to help businesses depreciate purchases faster against their taxable income, thereby encouraging businesses to invest in more equipment. Bonus depreciation allows businesses to recover the
costs of certain capital expenditures more quickly than under ordinary tax depreciation schedules.  Businesses can use bonus depreciation to immediately write off a percentage of the cost of depreciable property.  The new law makes 100 percent bonus depreciation available for qualified investments made after September 8, 2010 and before January 1, 2012. It also continues bonus depreciation, albeit at 50 percent, on property placed in service after December 31, 2011 and before January 1, 2013. There are special rules for certain longer-lived and transportation property. Additionally, certain taxpayers may claim refundable credits in lieu of bonus depreciation. 100 percent bonus depreciation is a valuable tax break and businesses have only a short window to take advantage of it.

Code Sec. 179 expensing. Along with bonus depreciation, the new law also provides for enhanced Code Sec. 179 expensing for 2012. Under current law, the Code Sec. 179 dollar and investment limits are $500,000 and $2 million, respectively, for tax years beginning in 2010 and 2011. The new law provides for a $125,000 dollar limit (indexed for inflation) and a $500,000 investment limit (indexed for inflation) for tax years beginning in 2012 (but not after).

Research credit. Many businesses urged Congress to make the research credit permanent after the credit expired at the end of 2009. While this proposal enjoyed significant support in Congress, its cost was deemed prohibitive. Instead, Congress extended the research tax credit for two years, for 2010 and 2011.

More incentives. Other valuable business incentives in the new law include extensions of:

  • 100 percent exclusion of gain from qualified small business stock
  • Transit benefits parity
  • Work Opportunity Tax Credit (with modifications)
  • New Markets Tax Credit (with modifications)
  • Differential wage credit
  • Brownfields remediation
  • Active financing exception/look-through treatment for CFCs
  • Tax incentives for empowerment zones
  • Special rules for charitable deductions by corporations and other businesses
  • And more

Energy

In 2010, Congress had been expected to pass comprehensive energy legislation including new and enhanced tax incentives. For a number of reasons, an energy bill did not pass. However, the new law extends some energy tax breaks for businesses. The new law also extends, but modifies, a popular energy tax break for individuals.
For businesses, one of the most valuable energy incentives is the Code Sec. 1603 cash grant in lieu of a tax credit program. This incentive encourages the development of alternative energy sources, such as wind energy. Other business energy incentives extended by the new law include excise tax and other credits for alternative fuels, percentage depletion for oil and gas from
marginal wells, and other targeted incentives.
Individuals who made energy efficiency improvements to their homes in 2009 or 2010 are likely familiar with the Code Sec. 25C energy tax credit.  This credit rewards individuals who install energy efficient furnaces or add insulation, or make other improvements to reduce energy usage. The new law extends the credit through 2011 but reduces some of its benefits. Although
2010 is soon over, there may still be time to take advantage of the more generous credit.

Estate and gift taxes

The federal estate tax, along with federal gift and generation skipping transfer (GST) taxes, was significantly overhauled in 2001. At that time, Congress set in motion a gradual reduction of the estate tax until abolishing it for 2010. Under budget rules, however, those changes could extend for only 10 years; starting in 2011, the estate tax had been scheduled to revert to its pre-2001 levels of 55 percent and a $1 million exclusion.

The new law revives the estate tax, but with a maximum estate tax rate of 35 percent with a $5 million exclusion. The revived estate tax is in place for decedents dying in 2011 and 2012. The new law gives estates the option to elect to apply the estate tax at the 35 percent/$5 million levels for 2010 or  to apply carryover basis for 2010. The new law also allows “portability” between
spouses of the maximum exclusion and extends some other taxpayer-friendly provisions originally enacted in 2001.