Economic Tax Growth and Tax Act of 2001
Congress has passed the largest tax reduction bill since the Economic Tax Recovery Act of 1981. Starting in 2001, the individual and corporate tax rates have been decreased, the child credits increased, and the retirement and education savings incentives have been expanded. Also, within the next several years, you can expect the marriage penalty relief to be reduced and the estate tax liability decreased.
Of course, the media has been quick to publicize the unprecedented act of the government sending a refund check to almost every taxpayer who has filed a return for 2000. The most difficult aspect to grasp is that over half of these tax benefits and savings will occur five years from now, and all are scheduled to be repealed after December 31, 2010. This makes tax planning difficult because no one knows if the postponed relief provisions will still be in effect and retained or repealed at a later date by future Congressional action.
Individual Rate Reduction
The new tax rates for individuals, which are currently at the 15, 28, 36, and 39.6 percent tax brackets, will eventually be reduced over the next five years to the 10, 15, 25, 28, 33 and 35 percent tax brackets. If you are single or married filing separately, the first $6,000 of your taxable income is taxed at 10% rather than at 15%. For heads of households the $10,000 is taxed at 10%. For married persons filing jointly, up to $12,000 will be taxed at 10%. After these income thresholds, the 15% tax bracket goes into effect.
The new 10% rate is retroactive to January 1, 2001. However, you do not have to wait until 2002, when you file your 2001 return to get the benefit of the new rate reduction. Instead, each taxpayer will receive a rate reduction credit for 2001. If you paid income taxes for 2000, you will receive up to $300 if you are single, $500 if you are head of household, and $600 if you are married filing a joint return. You should receive your check before the Fall, 2001 if you filed your 2000 return on time.
When you file your 2001 return next year, you will already have received the rate reduction and will not get it again. Any dependents who paid taxes in 2000 are not eligible for the rebate and do not get the benefit of 10% rates when they file their returns in 2001. If you paid no taxes in 2000, but will pay tax when you file for 2001, you may claim the reduced amount of taxes due to the 10% rate as a credit against your 2001 tax liability. If you receive a refund check in 2001 and end up not owing any taxes on your 2001 return, you will not have to repay that amount of your refund back to the government.
The new Tax Act provides that the 27% rate begins on July 1, 2001, replacing the prior 28% rate. The average rate between both is 27.5% for 2001, 27% for 2002 - 2003, 26% for 2004 - 2005, and 25% in 2006 and after. Keep in mind that these new tax rates are to be phased in over the next five years, rather than take effect immediately.
Alternative Minimum Tax
The alternative minimum tax system is designed so that high-income taxpayers, who can take advantage of various tax incentives and tax preference, still pay income taxes. The current AMT rates are 26% for the first $175,000 of alternative minimum taxable income in excess of an exemption amount plus 28% of the remaining taxable amount. Although the Tax Act does not provide any immediate relief, the exemption amounts used in computing the alternative taxable income amounts will be increased over the next four years.
Marriage Penalty Relief
A marriage penalty exists if you and your spouse pay more taxes when you file a joint return than if you were to file separately using the single filing status. The new tax law increases the standard tax deduction for married individuals, and expands the 15% tax bracket for married couples filing joint returns. Unfortunately, this marriage penalty relief does not begin until 2005, and key provisions will not be phased in until 2008-2009. If you claim an earned income credit, the 2001 act attempts to provide some parity between married and single taxpayers. If you are married filing jointly, the earned income credit "phase-out" (cut off point for which a taxpayer is eligible) is increased by $1000 for 2002 - 2004, $2000 for 2005 - 2007, and $3000 beginning after 2007.
Child Tax Credits
The new law doubles the existing child tax credit from $500 per child to $1000 per child, phased in over 10 years. The 2001 credit will be $600, with the full $1000 credit available by 2010. As a point of interest, with the extended phase-in period, only parents who now currently have children eight years old or under today will be able to enjoy the full child tax credit of $1000 in 2010.
You are allowed an increased adoption credit under the new law of up to $10,000 per child adopted, and doubles the starting point of the phase-out range from $75,000 to $150,000.
Dependent Care Tax Credit
The new law increases the credit rate from 30% to 35% and increases the amount of eligible employment-related expenses to which the credit rate can be applied from $2400 to $3000 per child. It also increases the beginning point of the income phase out from $10,000 to $15,000.
College Tuition Deduction
Under the new law, parents get the deduction for qualified education expenses. This should provide relief to those parents paying for their child's college education. If you are single with adjusted gross income of less than $65,000 ($130,000 for married filing jointly), you can take an above the line deduction for college tuition of $3,000 per year. For 2004 and 2005, this increases $4,000.
Before the enactment of the new law, savings vehicles called Education IRA permitted you to make limited contributions and eventually take distributions to pay for the qualified education expense on a tax-free basis. The new law greatly expanded the usefulness of these accounts in planning to accumulate funds to pay for a child's education. Education IRA had an annual contribution limit of $500 per child. Under the new law, you can now contribute $2,000 to an account annually for each child from birth through age 17. The new law also allows you to contribute until April 15 of the subsequent tax year. The prior law disallowed contributions to Education IRA after December 31.
New Rules for Deduction Student Loan Interest
The new law significantly increases the availability of the deduction for student loan interest. It also repeals the restriction that the deduction could only be taken with respect to the first 60 months during which student loan interest payments are required. Under the existing law, the deduction for student loan interest had also been significantly restricted by a rule that permitted a taxpayer to take the deduction only if their adjusted gross income fell below a certain threshold amount. The new law raises the income phase-out range from $40,000 - $50,000 to $50,000 - $65,000 for single taxpayers and from $60,000 - $75,000 to $100,000 - $130,000 for joint filers.
Qualified Tuition Plans
The new law expands the scope of qualified tuition plans. You will no longer be restricted to making prepayments of tuition and other higher education expense to state-sponsored qualified tuition programs. Under the new law, private institutions of post-secondary learning will also be able to sponsor qualified tuition programs. The new law also alters the tax treatment from qualified tuition plans. Distributions from state-sponsored qualified tuition programs will be excludable from income after December 31, 2001. Likewise, distributions from non-state programs will be excludable from income if made after December 31, 2002.
Retirement Accounts and Planning
The new law encompasses a considerable amount of pension reform provision. Beginning in 2001, the maximum annual contribution to an IRA increases to $3,000 (up from $2,000) with further increases scheduled in future years. As in the past, the actual amount of your permitted contribution depends on your income bracket. The increases in IRA contributions go to $4,000 in 2005 - 2007, and up to $5,000 per individual per year in 2008. If you are at least 50 years old in 2002, you can add an additional $500 to your regular IRA contribution. This catch up amount also increases in future yeasr, to $1000 in 2006.
Retirement Account Rollovers and Savings Tax Credits
Beginning in 2002, it will be easier to roll over the balance retirement account balances from one qualified retirement plan to another qualified plan. Currently, you cannot make a tax-free rollover of your IRA balances into a qualified plan such as a 401(k). Under the new law, you will be allowed to roll over amounts from your IRA into any eligible retirement plan, whether it is another IRA or a plan sponsored by your employer. Under the new law, you can get a retirement savings tax credit of up to $2,000 for contributions into a qualified plan, such as a 401(k) plan. The actual amount you get depends on your level of income for the year. This credit is in addition to any other deduction or exclusion that applies to retirement savings contributions. To be eligible for this tax credit, your adjusted gross income must be $50,000 or less for joint filers, $37,500 or less for heads of households, or $25,000 or less for single taxpayers.
The limit to 401(k) contributions has also been adjusted. The amount you can contribute to your 401(k) or similar plan is increased to $11,000 next year. It will eventually be increased to $15,000 by the year 2006. The limit on annual additions to a defined contribution plan is an overall limit. It is a limit on the total of contributions by your employer plus your own contributions. This limit increase is intended by Congress to encourage taxpayers to save for their retirement.
Estate and Gift Tax Planning
Because of the complexity and uncertainty created by the 2001 Tax Relief Act, estate planning has become more urgent than ever. Instead of repealing the estate tax, the estate tax will phase out over the next nine years, be repealed in 2010, and will automatically be reinstated in 2011. Generally, the estate tax and generation skipping transfer tax will be repealed in 2010 after a long transition period. This means that more of your property can be transferred to your heirs by gift or though your estate, without additional tax. During the transition period, the tax rates will be gradually reduced. Gift tax rates will also be reduced, but this tax will not be repealed. The estate tax applied to property you own at the time of death.
The highest tax rate will be 50% (instead of 60%) and the rate will go down to 45% before it is finally repealed. A fixed amount of property can be exempt from state taxes. The exemption immediately goes up to $1 million from $675,000. Eventually, the amount increases to $3.5 million in 2009, before being repealed in 2010, then being reinstated back to the $1 million exemption and the highest estate tax rate will be 55%. The gift tax rate for gifts you make during your lifetime has also been reduced, from 50% now, and eventually be reduced to 35% in 2010. There is no change in the annual exclusion of $10,000 for tax free gifts to heirs of your estate.
Be advised that this new tax law, by its own terms, expires at the end of 2010. It is anyone's guess when these new tax law provisions will be extended or re-written in future tax legislation. Congress has written the new law to allow it to make such provisions and extensions in future legislation. But the automatic expiration of these laws reinforced the ongoing need to consult your tax advisor when planning for your financial future.