5 Things Everyone Should Know About This Year's Tax Changes

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We saw 2010 close with last-minute wheeling and dealing to satisfy various objectives on both sides of the aisle. Politics aside, the bottom line is that many special tax breaks, credits, and pieces of legislation that were set to expire in 2010 ended up being extended into 2011 and beyond. Additionally, some parts of the tax code are distinctly different in 2011 compared to last year. With a focus on what's different (as opposed to unchanged extensions), here are some key tax changes you'll see in 2011:

1. Temporary Payroll Tax Cut

The payroll tax that most employees face on their first $106,800 of earnings will be reduced by 2% this year only, from 6.4% to 4.2%. The intent of this tax break is to stimulate the economy by having a little extra money show up in each paycheck, which is believed to be more stimulative than a simple one-time "rebate" check like we've seen in the past.

Whatever the ultimate outcome for the economy at large, what this means to you is a virtual 2% raise (tax-free!) up to that $106,800 cap, at which point the payroll tax phases out anyway. This break is currently slated for 2011 only, and it would be highly unlikely to see this extended again since the payroll tax funds Social Security. (See also: What is the Social Security Tax?)

2. FSA Deductions Changed

Part of the health care reform legislation recently enacted is a key change to Flex Savings Accounts (FSAs): You can no longer deduct over-the-counter (OTC) medicines without a prescription. While this may not have a sizable impact on many people, a common year-end activity for people who had unused FSA contributions was to run down the pharmacy and stock up on aspirin and other medications, since you have to "use it or lose it."

The net impact is that you'll have to be a little more careful in how you plan your contributions in future years. And if you used to spend heavily on OTC meds, note that the deduction is gone and is not coming back. (See also: How Healthcare Reform Change the Way You Pay Taxes.)

3. Energy Efficient Tax Credits Diminished

Where in 2009 and 2010 you could deduct 30% of up to $5,000 spent for various energy-efficient upgrades to your home for a total of $1,500 in credits, in 2011, this credit is now capped at $500. The credit is also more restrictive, with a maximum of $200 for windows and $300 for heating systems, and if you took credits in the 2009-2010 session, you cannot participate in this year's $500 credit program (i.e. no double-dipping).

In effect, given the sizable investments new windows and heating units often require and the comparatively small credit, you may not be enticed to jump on a home upgrade just because of the credit. However, if any of these upgrades are required anyway, you'll want to confirm that the upgrade adheres to the government specifications (see Energy Star Requirements), save the documentation, and realize the credit on your tax return.

4. New Estate Tax Criteria Established

With the estate tax moratorium set to expire at the end of 2010, legislation was enacted to set new criteria for the estate tax in 2011 and 2012. Now individuals will see the first $5 million exempt, and couples will see $10 million exempt from federal estate taxes. If that amount is exceeded, a 35% tax will be levied.

5. Business Investment Incentive

A program was established for businesses meant to spur near-term capital investment instead of extending such decisions into the future. Companies will now be able to fully depreciate capital investments in the year of purchase. Specifically, the IRS code Section 179 limits were increased over last year, thus allowing a business to deduct up to $500,000 of qualified capital expenditures subject to a dollar-for-dollar phase-out once these expenditures surpass $2 million.

While this piece may not seem relevant to most individual taxpayers, many small business owners may consider this enough to push them over the threshold and pull the trigger on new equipment upgrades now as opposed to waiting for the economy to fully recover.

These were five significant tax law changes for 2011, but there are some more out there, as well as plans for future tax changes already in the works. For advance planning, check out this nifty tax change summary showing changes anticipated all the way out to 2017.