Tax Tip for Aug/Sep 2001
Summary of 2001
Tax Relief Act
The Economic Growth and Tax Relief
Reconciliation Act of 2001 (The Tax Relief Act)
Below is a brief summary of the
highlights from the Tax Relief Act of 2001 that was passed earlier this year. The
relief measures form the largest tax cut in more than 20 years. They challenge you and
your tax advisor to reconsider a myriad of tax planning assumptions. The new law
imposes a complicated array of unprecedented back-loaded (i.e., time-delayed)
benefits, with varying effective dates that span 10 years. Some provisions are
retroactive; some start next year but require immediate planning to maximize
benefits; others won’t start until 5, or even 10 years from now, but
nevertheless may impact you this year.
General Provisions
Gradual Rate Cuts
Despite initial ambitious plans to have only four rate brackets that
would cap at 33 percent, Congress eventually compromised and, in doing so,
actually added a rate bracket. There will now be six rate brackets for
individuals.
The new 10 percent rate is carved out of the existing 15 percent
bracket. For 2002-2007, the new 10 percent bracket will apply to the first
$12,000 of income for couples, $6,000 for singles, and $10,000 for heads of
household ($14,000/ $7,000/ $10,000 after 2008, and adjusted for inflation
thereafter).
The new 10 percent rate technically starts January 1, 2002. A credit is
available to taxpayers in 2001 that in effect accelerates to a 10 percent income
tax rate bracket benefit for 2001. This means an added $300 in the pockets of most taxpayers ($600 for
joint filers, $500 for heads of household) in 2001 in the form of advance refund
checks. The advance refund checks will be sent to all taxpayers who are eligible
based on their 2000 returns. Trusts and estates, nonresident aliens and
taxpayers claimed as dependents are not eligible for an advance refund.
Here is the schedule under which the rate cuts are being implemented:
Rate Reduction Schedule
|
Calendar Year
|
Year 15% rate
|
28% rate
|
31% rate
|
36% rate
|
39.6% rate
|
|
2001*
|
Refund
credit
|
27%
|
30%
|
35%
|
38.6%
|
|
2002-2003
|
Partial
10%
|
27%
|
30%
|
35%
|
38.6%
|
|
2004-2005
|
No
change
|
26%
|
29%
|
34%
|
37.6%
|
|
2006
and later
|
No
change
|
25%
|
28%
|
33%
|
35%
|
*Effective
July 1, 2001
Marriage
Penalty Relief
The
marriage penalty is being reduced in several different ways over the next
decade. Beginning in 2005, the Married Joint standard deduction will gradually
be raised until it equals two times the Single standard deduction in 2009.
Similarly, the top end of the 15% bracket will begin increasing in 2005 until it
reaches two times that of the single 15% bracket in 2008.
Itemized
Deduction and Personal Exemption Phase Outs
Both the
Itemized Deduction Limitation and the Personal Exemption Phase Out, which cause
taxpayers above certain income levels to lose these deductions, will be reduced
and then eliminated on the following schedule:
|
Tax Year
|
Reduced by
|
|
2006-2007
|
1/3
|
|
2008-2009
|
2/3
|
|
2010
|
Eliminated
|
Alternative
Minimum Tax
In a very
small and temporary attempt to stem the tide of taxpayers falling victim to AMT,
the exemption amount for married taxpayers was raised $4,000 to $49,000 and that
of single taxpayers was raised $2,000 to $35,750. This measure is only effective
from 2001-2004, so Congress will have to revisit this issue for a more permanent
solution. On a more positive note, the Child Tax Credit and the Adoption Credit
are now permanently allowed against AMT.
Child Related Provisions
Child
Tax Credit
The
maximum credit per child will gradually increase beginning with $600 in 2001,
until it reaches $1,000 in 2010. The credit will be refundable for many
taxpayers now. Unfortunately, the income limitations remain the same.
Child
and Dependent Care Credit
The
new law increases the dependent care credit rate from 30 to 35 percent,
increases the amount of eligible employment-related expenses from $2,400 to
$3,000 (from $4,800 to $6,000 for more than one qualifying individual), and
increases the beginning point of phase-out income to $15,000 of adjusted gross
income, starting in 2003.
Adoption
Credit
The
maximum Adoption Credit will become $10,000 in 2002 (up from $5,000/or $6,000
for a special needs child). The AGI limit will double from $75,000 to $150,000.
The credit is now permanently allowed to be taken against AMT (Alternative
Minimum Tax). Tax free Employer Provided Adoption Assistance is also increased
to $10,000.
Education
Related Provisions
Education
IRA
Distributions
from education individual retirement accounts are free from federal taxation if
they are used to pay for qualified education expenses. The new legislation
greatly expands the prominence that education IRAs will play in future family
savings strategies.
In 2002,
the maximum contribution will increase to $2,000 (up from $500), the gross
income phase out range for joint filers will equal two times that of single
filers at $190,000-$220,000 (up from $150,000-$160,000), the contribution
deadline will be extended to April of the following year (instead of year end),
and the funds may be used for elementary and secondary school tuitions,
supplies, etc. (in addition to college expenses). Covered expenses include
tutoring, computer equipment, room and board, uniforms and extended day program
costs.
Student
Loan Interest Deduction
Effective
for payments made in 2002 and after, the 60 month limit is eliminated (under
prior law, interest had to be attributable to the 1st 60 months of
the loan). The phase out range for single filers increases to $50,000-$65,000
(up from $40,000-$55,000). The phase out range for joint returns increases to
twice that of single filers at $100,000-$130,000 (up from $60,000-$75,000).
Education
Expense Deduction
In a move
to give an education tax break to those who cannot qualify for the Hope and
Lifetime Learning credits, a new, but temporary, deduction was created.
This new additional education deduction allows tuition to be deducted
"above the line", which means you do not have to itemize to take the
deduction. The income limits shown below are for Single and Head of Household
returns, Married Joint limits are double. The amounts and income limits are as
follows:
|
Tax Years
|
AGI - Single
|
Max. Deduction
|
|
2002-2003
|
$65,000
|
$3,000
|
|
2004-2005
|
$65,000
|
$4,000
|
|
2004-2005
|
$80,000
|
$2,000
|
Employer
Provided Education Assistance
New
legislation makes this $5,250 tax break permanent as of 2001. Beginning in 2002
graduate level courses will also be eligible.
Qualified
Tuition Plans
The new law expands the scope of qualified tuition programs and alters
the tax treatment of distributions. Currently, taxpayers may pre-pay higher
education tuition costs only under state-sponsored qualified tuition programs.
Now, private institutions of post-secondary learning will be able to sponsor
qualified tuition programs as well. Additionally, distributions from
state-sponsored qualified tuition programs will be excludable from gross
income if made after December 31, 2001. Distributions from non-state
programs would be excludable if made after December 31, 2003.
Retirement
Related Provisions
Increased
IRA Limits
Maximum annual IRA contributions will be increased
according to the following schedule:
|
Tax Year
|
Maximum
|
|
2002-2004
|
$3,000
|
|
2005-2007
|
$4,000
|
|
2008
|
$5,000
|
Taxpayers
who are age 50 or over will be entitled to make additional "catch up"
contributions. If this applies to you, you may add the following amounts to the
general limits above:
|
Tax Year
|
Additional Amount
|
|
2002-2005
|
$ 500
|
|
2006+
|
$1,000
|
Temporary
Low Income Credit for Retirement Contributions
This is a
new credit created to further encourage low income taxpayers to make
contributions to retirement plans. The credit exists only from 2002-2006 and is
available to taxpayers who are over age 18, not full time students, and not
claimed as dependents on someone else's return. The credit can be 10%, 20%, or
50% of the contribution, up to a $2,000 contribution. Credit percentages are
based on income and are as follows:
|
Credit %
|
Single
|
Head of Household
|
Joint
|
|
50%
|
up to $15,000
|
up to $22,500
|
up to $30,000
|
|
20%
|
$15,000-$16,250
|
$22,500-$24,375
|
$30,000-$32,500
|
|
10%
|
$16,250-$25,000
|
$24,375-$37,500
|
$32,500-$50,000
|
401k,
403b, and 457 plans
Currently
annual contributions to 401k and 403b plans are limited to $10,500 and 457 plans
are limited to $8,500. All 3 types of plans will gradually increase until all
are at $15,000 for tax year 2006, and will be indexed for inflation after 2006.
In addition, taxpayers over age 50 will be eligible to make additional
"catch up" contributions. Increases are on the following schedule:
|
Tax Year
|
Contribution Limit
|
Over Age 50
|
|
2002
|
$11,000
|
+$1,000
|
|
2003
|
$12,000
|
+$2,000
|
|
2004
|
$13,000
|
+$3,000
|
|
2005
|
$14,000
|
+$4,000
|
|
2006
|
$15,000
|
+$5,000
|
SIMPLE
plans
The
current annual contribution limit for a SIMPLE is $6,500, which will be
gradually increased until a $10,000 limit is reached in 2005. Taxpayers over age
50 will be eligible to make additional "catch up" contributions.
Limits will be indexed for inflation after 2005. Increases are on the following
schedule:
|
Tax Year
|
Contribution Limit
|
Over Age 50
|
|
2002
|
$7,000
|
+$500
|
|
2003
|
$8,000
|
+$1,000
|
|
2004
|
$9,000
|
+$1,500
|
|
2005
|
$10,000
|
+$2,000
|
|
2006
|
$10,000 indexed
|
+$2,500
|
"Roth"
type 401k and 403b plans
In 2006 a
"Roth" option will be added for 401k and 403b plans. For tax purposes
these plans would be treated like a Roth IRA in that the contributions would not
be tax deferred (no tax break), but the funds would be completely tax free upon
withdrawal at retirement.
Faster
Vesting Schedules
This part
of the legislation would mandate that employers shorten vesting periods to help
those who change jobs frequently. Vesting options would be either completely at
3 years service, or a gradual vesting from years 2-6. Current trends are
completely at 5 years of service or gradually from years 3-7.
Estate
Tax Related Provisions
Estate
Tax
The
maximum estate tax rate will be gradually reduced from the current 55% until the
maximum rate is 45% in 2009. The estate tax would be repealed completely in
2010. However, these provisions run out at the end of 2010 so, unless a future
administration makes it permanent, the estate taxes in effect in 2001 will again
be in effect in 2011. The purpose of such a provision is simply so that the
current Congress does not have to show the full cost of repealing the estate
tax. If they were to show the full cost, they could not pass this legislation.
Conclusion:
Obviously, all of the talk of simplifying the tax code has fallen on deaf ears.
The sheer volume of The Tax Relief Act of 2001, along with the numerous
provisions that are time-delayed, make this one of the more complex tax code
changes in history. This is so, even without the complication of more tax
legislation that is bound to follow.
Please give me a call if you would like to discuss
any of the provisions of the new law and how it will impact your personal tax
situation.
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