Any day now, you'll receive your 2011 W-2 and 1099s. That's the official signal to begin thinking about last year's tax return. Before actually getting to work, you should be aware of some key changes. Here's the second installment of our two-part series on the most important new things to know when preparing on your 2011 return. (For Part 1, see What's New for Tax Form 1040).
If You Did a Roth Conversion in 2010
If you were among the many who converted a traditional IRA into a Roth account in 2010, the conversion was treated as a taxable liquidation of your traditional IRA followed by a contribution to the Roth account. For 2010 conversions only, you had the option of reporting half the resulting taxable income on your 2011 Form 1040 and the other half on your 2012 return -- instead of reporting it all in 2010. You could do the same drill with a qualified retirement plan distribution (from a 401(k) plan, a profit-sharing plan, and the like) that was rolled over into a Roth IRA (another type of Roth conversion transaction). In other words, you could defer the tax hit from a 2010 conversion until 2011 and 2012. Nice.
If you took advantage of the deferral option for a 2010 conversion, you must now report half the conversion income on Line 15b of your 2011 Form 1040. (That amount should be shown on Line 20a of the Form 8606 (Nondeductible IRAs) that you filed with your 2010 return.) For a 2010 qualified retirement plan conversion, you must report half the conversion income on Line 16b of your 2011 Form 1040. (That amount should be shown on Line 25a of the Form 8606 that you filed with your 2010 return.)
Note: If you did a 2010 Roth conversion and did not take advantage of the deferral option, no action is necessary with your 2011 return--because you already reported all the conversion income on your 2010 return.
Credits for Energy-Efficient Home Improvements
For 2011, you can potentially claim a federal income tax credit of up to $500 based on expenditures for qualified energy-efficient home improvements such as new windows, doors, insulation, roofs, and central air conditioners. If you claimed credits in earlier years, they are subtracted from the $500 limit. (For 2010, the maximum credit was a much-more-generous $1,500.) If you spent money on more esoteric energy-efficient improvements, like a solar water heating system or geothermal heat pump, you can potentially claim a separate credit for up to 30% of the cost. For the full story on these credits, see Tax Breaks For Energy-Saving Home Improvements.
Reduced Self-Employment Tax Bill
For 2011 only, the Bush tax cut extension legislation included a reduction in the Social Security tax component of the self-employment (SE) tax from the normal 12.4% of net SE income to 10.4%. The Medicare tax component of the SE tax remained at the usual 2.9% rate. For 2011, the net SE income ceiling for the Social Security tax component of the SE tax was $106,800. Therefore, the SE tax rate on your first $106,800 of net 2011 SE income is 13.3% (10.4% for Social Security plus 2.9% for Medicare) versus the usual 15.3%. The maximum amount you can save from the Social Security tax reduction is $2,136 (2% x $106,800). The savings will be reflected on your Schedule SE (Self-Employment Tax), which is filed with your 1040.
Page 1 Deduction for Self-Employment Tax Is Not Reduced
If you are self-employed you know that you can usually deduct exactly half of your SE tax bill on Page 1 of Form 1040. Due to the aforementioned reduction in the Social Security tax component of the SE tax, there's a new drill for your 2011 return. Your SE tax deduction equals 57.51% of the SE tax amount, as long as that amount does not exceed $14,204. If your SE tax bill exceeds $14,204, you multiply the SE tax amount by 50% and then add $1,067. These calculations are made on Line 6 of the 2011 version of Schedule SE. The effect is to allow you to claim an SE tax deduction equal to what your write-off would have been without the Social Security tax cut.
Example: Phil is self-employed. He operates his solo computer consulting business as a sole proprietorship. In 2011, he owes SE tax on net SE income of $95,000. His SE tax bill is therefore $12,635 ($95,000 x 13.3% reduced SE tax rate for 2011). Without the cut in the Social Security tax component of the SE tax rate, Phil's SE tax bill would have been $14,535 ($95,000 x 15.3% normal SE tax rate).
Phil's SE tax deduction on page 1 of Form 1040 is $7,266 (.5751 x $12,635 = $7,266). This is the same deduction that would have been allowed if the normal 50% deduction rate and the normal 15.3% SE tax rate applied (50% x $14,535 = $7,267). Actually, it's off by a dollar, but that's due to rounding.
Bottom Line: Your Page 1 SE tax deduction is the same as it would have been without the Social Security tax reduction.
Your Tax Preparer Might E-File Your Return This Time
Over the last few years, Congress has made tax-law changes that place increasing pressure on professional return preparers to electronically file more and more returns. As a result, your preparer might be forced to e-file your 2011 Form 1040 even if your returns for earlier years have always been done on paper. Get used to it.