| The 2001
TAX RELIEF ACT |
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| This report
summarizes those changes and provides planning suggestions. It is intended to
give you an overall view of the new law. |
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| Note: Be
aware that many of the changes do not take effect immediately, but either are
phased in over time, or take effect in later years. Further, the new law
changes are slated to expire at the end of 2010. That means that unless
Congress takes action to make the changes permanent, we will, in the year 2011,
go back to the tax system as it existed before enactment of this
law. |
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| INCOME TAX RATE
REDUCTION |
| Many taxpayers
will pay less income tax under the 2001 Tax Relief Act. Through changes to the
existing tax structure, the new tax law cuts income taxes for individuals;
further, it gets rid of the phase-outs of itemized deductions and personal
exemptions for higher-income taxpayers. |
| Planning
Tip: In general, because income tax rates will be falling in the future, it
makes sense for taxpayers to try to delay income to future years-assuming they
have control over when an item of income is received. |
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| Planning
Tip: If a taxpayer is usually due a bonus at year-end, he or she may be
able to defer receipt of these funds until January of the next year. This can
defer the payment of taxes (other than the portion withheld) for another year.
Self-employeds can defer sending invoices or bills to taxpayers or customers
until after the new year begins. |
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| New 10% Rate
Bracket |
| The new law
creates a new 10% regular income tax bracket for a portion of taxable income
currently taxed at 15 percent, effective for taxable years beginning after
2000. The 10% rate bracket applies to the first $6,000 of taxable income for
single individuals ($7,000 for 2008 and thereafter), $10,000 of taxable income
for heads of households, and $12,000 for married couples filing joint returns
($14,000 for 2008 and thereafter). |
| Reduction in
Individual Income Tax Rates |
| The new law
also reduces the other regular income tax rates, effective July 1, 2001. The
present-law regular income tax rates of 28 percent, 31 percent, 36 percent, and
39.6 percent are phased-down over six years to 25 percent, 28 percent, 33
percent, and 35 percent, effective after June 30, 2001. |
| This table
shows the schedule of regular income tax rate reductions. |
| Calendar
Year |
28% rate
reduced to: |
31% rate
reduced to: |
36% rate
reduced to: |
39.6% rate
reduce to: |
| 2001–2003* |
27% |
30% |
35% |
38.6% |
| 2004–2005 |
26% |
29% |
34% |
37.6% |
| 2006 and
later |
25% |
28% |
33% |
35% |
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| Rate
Reduction Credit for 2001 |
| The new law
includes a rate reduction credit for 2001, intended to stimulate the economy by
delivering the benefit of the new 10% income tax rate bracket before year-end.
Under the 2001 TRA, taxpayers would be entitled to a credit in tax year 2001 of
5 percent (the difference between the 15% rate and the 10% rate) of the amount
of income otherwise eligible for the new 10% rate. The maximum credit will be
$300 in the case of a single individual, $500 in the case of a head of
household, and $600 in the case of a married couple filing a joint return. This
credit is in lieu of the 10 percent rate bracket for 2001. |
| Note:
Most taxpayers will receive this credit in the form of a check issued by the
Treasury Department by October 1, 2001, as long as they timely filed their 2000
tax returns. Taxpayers who filed late or under extensions will receive checks
later in the fall. |
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| Phase-Out of
Itemized Deductions |
| The new law
gradually eliminates the phase-out of itemized deductions for all taxpayers.
The limitation on itemized deductions is reduced by one-third in 2006 and 2007,
and by two-thirds in 2008 and 2009. The phase-out is eliminated in
2009. |
| Phase-Out of
Restrictions on Personal Exemptions |
| The new law
phases out the restrictions on personal exemptions. The current-law personal
exemption phase-out is reduced by one-third in 2006 and 2007, and by two-thirds
in 2008 and 2009. The provision is fully effective for taxable years beginning
after 2009. |
| Note:
Taxpayers who used to lose part or all of the tax benefit of the itemized
deduction and personal exemption because they had higher income will, between
2006 and 2010, gradually regain the total use of these tax benefits. As a
result, these taxpayers will pay less income tax. |
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| CHILD-RELATED TAX
BENEFITS |
| The new law
makes various changes to tax benefits related to children. For instance,
taxpayers with children will receive a tax credit of $600 per qualifying child
in 2001, up from $500 in 2000. Further, the new law expands and extends the
adoption tax credit, and expands the dependent-care credit. |
| Child Tax
Credit Increased and Expanded |
| The new law
increases the child tax credit to $1,000, phased in over ten years, effective
for taxable years beginning after December 31, 2000. |
| This table
shows how the child tax credit increases over the years. |
| Calendar Year |
Credit Amount Per Child |
| 2001–2004 |
$600 |
| 2005–2008 |
$700 |
| 2009 |
$800 |
| 2010 and later |
$1,000 |
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| The new law
also makes the child credit refundable (i.e., payable even when there is no tax
liability) to the extent of 10 percent of the taxpayer's earned income over
$10,000 for 2001–2004. The percentage is increased to 15 percent for
calendar years 2005 and thereafter. The $10,000 amount is indexed for inflation
beginning in 2002. Families with three or more children are allowed a
refundable credit for the amount by which the taxpayer's Social Security taxes
exceed the taxpayer's earned income credit (the present-law rule), if that
amount is greater than the refundable credit based on the taxpayer's earned
income in excess of $10,000. |
| The new law
provides that the refundable portion of the child credit does not constitute
income, and shall not be treated as "resources" for purposes of
determining eligibility or the amount or nature of benefits or assistance under
any federal program or any state or local program financed with federal
funds. |
| The new law
provides that the refundable child tax credit will no longer be reduced by the
alternative minimum tax. In addition, the new law allows the child tax credit
to the extent of the full amount of the individual's regular income tax and
alternative minimum tax. |
| The provision
generally is effective for taxable years after 2000. The provision relating to
allowing the child tax credit against alternative minimum tax is effective
after 2001. |
| Extension
and Expansion of Adoption Tax Benefits |
| The new law
permanently extends the adoption credit for children other than special needs
children. The maximum credit is increased to $10,000 per eligible child,
including special needs children. A $10,000 credit is provided in the year a
special needs adoption is finalized, regardless of whether the taxpayer has
qualified adoption expenses. |
| The beginning
of the income phase-out range is increased to $150,000 of modified adjusted
gross income. |
| Finally, the
adoption credit is allowed against the alternative minimum tax,
permanently. |
| The new law
permanently extends the exclusion from income for employer-provided adoption
assistance. The maximum exclusion is increased to $10,000 per eligible child,
including special needs children. In the case of a special needs adoption, the
exclusion is provided regardless of whether the taxpayer has qualified adoption
expenses. The beginning of the income phase-out range is increased to $150,000
of modified adjusted gross income. |
| The new rule
generally is effective after 2001. The provisions that extend the tax credit
and exclusion from income for special needs adoptions regardless of whether the
taxpayer has qualified adoption expenses are effective after 2002. |
| Expansion of
Dependent-Care Tax Credit |
| The new law
increases the maximum amount of eligible employment-related expenses from
$2,400 to $3,000, if there is one qualifying child or individual (from $4,800
to $6,000, if there are two or more qualifying children or individuals) and
increases the maximum credit from 30 percent to 35 percent. The new law
modifies the phase-down of the credit so that it begins at $15,000 of adjusted
gross income. The provision is effective after 2001. |
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| "MARRIAGE PENALTY"
RELIEF |
| The new law
relieves some of the effect of the so-called "marriage penalty"
— that quirk in the tax system under which two single people who live
together and both have earned income will pay less combined income tax than a
married couple in the same situation. |
| Standard
Deduction Increased |
| The new law
increases the basic standard deduction for joint filers to twice the basic
standard deduction for a single filer. This increase is phased in over five
years beginning in 2005, and will be fully phased in for 2009 and
thereafter. |
| Expansion of
the 15% Rate Bracket The new law increases the size of the 15% regular income
tax rate bracket for joint filers to twice the size of the corresponding rate
bracket for an unmarried individual filing a single return. The increase is
phased in over four years, beginning in 2005. |
| Earned
Income Credit Relief and Simplification |
| For joint
filers, the new law increases the beginning and ending of the earned income
credit phase-out by $1,000 for 2002–2004; by $2,000 for 2005–2007;
and by $3,000 after 2007. The $3,000 amount is adjusted annually for inflation
after 2008. |
| The new law
simplifies definitions related to the earned income credit in various
ways. |
| Note:
The new law authorizes the IRS, beginning in 2004, to use math error authority
to deny the earned income credit if the Federal Case Registry of Child Support
Orders indicates that the taxpayer is the noncustodial parent of the child with
respect to whom the credit is claimed. |
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| The new
provisions generally are effective for taxable years beginning after 2001. The
provision to authorize the IRS to use math error authority if the Federal Case
Registry of Child Support Orders indicates the taxpayer is the noncustodial
parent is effective in 2004. |
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| EDUCATION-RELATED
BENEFITS |
| The new law
makes various tax changes related to education. The highlights are discussed
here. |
| Education
IRAs |
| The new law
increases the annual limit on contributions to education IRAs from $500 to
$2,000, and includes elementary and secondary school expenses as
"qualified education expenses" that may be paid tax-free from an
education IRA. |
| The new law
also increases the phase-out range for joint filers to twice the range for
single taxpayers. Thus, the phase-out range for joint filers is $190,000 to
$220,000 of modified adjusted gross income. |
| Note:
The new law provides that various age limitations do not apply to special needs
beneficiaries. |
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| The new law
clarifies that corporations and other entities (including tax-exempt
organizations) can make contributions to education IRAs, regardless of the
income of the corporation or entity during the year of the
contribution. |
| The new law
allows a taxpayer to claim a HOPE credit or Lifetime Learning credit for a
taxable year and to exclude from gross income amounts distributed (both the
contributions and the earnings portions) from an education IRA on behalf of the
same student, as long as the distribution is not used for the same educational
expenses for which a credit was claimed. |
| The new law
repeals the excise tax on contributions made by any person to an education IRA
on behalf of a beneficiary during any taxable year in which any contributions
are made by anyone to a qualified State tuition program on behalf of the same
beneficiary. |
| The provisions
modifying education IRAs are effective for taxable years beginning after
2001. |
| Exclusion
for Employer-Provided Educational Assistance |
| The new law
extends the exclusion for employer-provided educational assistance to graduate
education and makes the exclusion (as applied to both undergraduate and
graduate education) permanent, effective as to courses beginning after
2001. |
| Student Loan
Interest Deduction |
| The new law
increases the income phase-out ranges for eligibility for the student loan
interest deduction to $50,000 to $65,000 for single taxpayers and to $100,000
to $130,000 for joint filers. These income phase-out ranges are adjusted
annually for inflation after 2002. The new law repeals the limit on the number
of months during which interest paid on a qualified education loan is
deductible, and also repeals the rule under which voluntary payments of
interest are not deductible. |
| The provision
is effective for interest paid on qualified education loans after
2001. |
| Deduction
for Qualified Higher Education Expenses |
| The new law
provides for an above-the-line deduction for qualified higher education
expenses paid by the taxpayer during a taxable year. Qualified higher education
expenses are defined in the same manner as for purposes of the HOPE
credit. |
| In 2002 and
2003, taxpayers with adjusted gross income that does not exceed $65,000
($130,000 in the case of joint filers) are entitled to a maximum deduction of
$3,000 per year. Taxpayers with adjusted gross income above these thresholds
would not be entitled to a deduction. In 2004 and 2005, taxpayers with adjusted
gross income that does not exceed $65,000 ($130,000 in the case of joint
filers) are entitled to a maximum deduction of $4,000 and taxpayers with
adjusted gross income that does not exceed $80,000 ($160,000 in the case of
married taxpayers filing joint returns) are entitled to a maximum deduction of
$2,000. |
| The provision
is effective for taxable years beginning after 2001. |
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| ESTATE AND GIFT TAX
CHANGES |
| The new law
reduces estate, gift, and generation-skipping taxes between 2002 and 2009, and
then repeals the estate and generation-skipping taxes in 2010. After the
repeal, only the gift tax will remain. |
| During the
phase-out period, the amount that can be passed without incurring estate or
gift tax will gradually be increased, and the estate tax rates will be
reduced. |
| Note:
Again, bear in mind that the new tax law provisions are automatically slated to
expire at the end of 2010, so if Congress does not take steps to re-enact the
provisions before then, the estate tax as we knew it before these tax changes
will spring back into effect. |
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| Here are the
details of the gradual estate tax repeal: |
| Under the new
law, in 2002, the 5% surtax (which phases out the benefit of the graduated
rates) and the estate tax rates in excess of 50 percent are repealed. In
addition, in 2002, the unified credit exemption amount for estate and gift tax
purposes — generally speaking, the amount allowed to pass free of estate
and gift tax — is increased to $1 million from its current amount of
$675,000. |
| In 2003, the
estate and gift tax rates in excess of 49 percent are repealed. In 2004, the
estate and gift tax rates in excess of 48 percent are repealed, and the unified
credit exemption amount for estate tax purposes is increased to $1.5 million.
(The unified credit exemption amount for gift tax purposes remains at $1
million as increased in 2002.) In addition, in 2004, the family-owned business
deduction is repealed. In 2005, the estate and gift tax rates in excess of 47
percent are repealed. In 2006, the estate and gift tax rates in excess of 46
percent are repealed, and the unified credit exemption amount for estate tax
purposes is increased to $2 million. In 2007, the estate and gift tax rates in
excess of 45 percent are repealed. In 2009, the unified credit exemption amount
is increased to $3.5 million. In 2010, the estate and generation-skipping
transfer taxes are repealed. |
| From 2002
through 2009, the estate and gift tax rates and unified credit exemption amount
for the estate tax are as shown below. |
| Calendar
Year |
Estate and GST Tax
Deathtime Transfer
Exemption |
Highest Estate and
Gift Tax Rates
|
| 2002 |
$1
million |
50% |
| 2003 |
$1
million |
49% |
| 2004 |
$1.5
million |
48% |
| 2005 |
$1.5
million |
47% |
| 2006 |
$2
million |
46% |
| 2007 |
$2
million |
45% |
| 2008 |
$2
million |
45% |
| 2009 |
$3.5
million |
45% |
| 2010 |
N/A (taxes
repealed) |
top
individual rate
under the bill
(gift tax only)
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| In 2010, the
estate and generation-skipping transfer taxes are repealed. |
| Also beginning
in 2010, the top gift tax rate will be the top individual income tax rate as
provided under the new law, and, except as provided in regulations, a transfer
to trust will generally be treated as a taxable gift, unless the trust is
treated as wholly owned by the donor under the "grantor trust"
provisions of the tax law. |
| Once repeal of
the estate and generation-skipping transfer taxes has been effected, the rules
governing determination of the tax basis of inherited or gifted property will
change. Current rules, providing for a fair market value (i.e., stepped-up) tax
basis for property acquired from a decedent, will be repealed. A modified
carryover basis regime generally takes effect, under which recipients of
property transferred at death will receive a basis equal to the lesser of the
adjusted basis in the hands of the decedent or the fair market value of the
property on the date of death. |
| Planning
Tip: Most estate plans will have to be revamped to take into account the
new rules. Further, estate planning for wealthy taxpayers during the coming
years will contain less emphasis on lifetime giving. |
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| RETIREMENT SAVINGS
CHANGES |
| The new law
makes extensive changes to the rules relating to individual retirement
arrangements ("IRAs") and qualified pension plans, including the
following: |
| • |
The maximum amount that can be contributed to an IRA each year will
increase to $3,000 in 2002. It will remain at $3,000 for 2003 and 2004, and
then will increase to $4,000 for 2005 through 2007, and $5,000 for 2008 and
thereafter. The contribution limit will be adjusted for inflation after 2008.
(The AGI limitations for IRA deductions have not changed.) |
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| • |
Maximum permissible yearly contributions to 401(k) plans and to other
types of plans have also been raised. |
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| Important: Those aged 50 or over will be allowed to make
additional "catch-up" contributions, over and above the general
contribution limits. |
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| • |
The law makes a general overhaul of retirement plan provisions,
including providing for faster vesting. |
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| • |
The contribution limit for education IRAs is increased to $2,000 (from
$500) in 2002; the law also makes other education-related changes that are
beneficial to the taxpayer. |
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| Planning
Tip: Taxpayers whose employers offer 401(k) or 403(b) plans should
contribute as much as possible to these plans to defer income and accumulate
retirement assets. |
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| Planning
Tip: Taxpayers who have their own businesses should consider setting up and
contributing as much as possible to retirement plans, which are also allowed
for sideline businesses. |
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| Planning
Tip: Taxpayers with income from wages or self-employment income can
contribute up to $2,000 to a traditional or a Roth IRA. They may also be able
to contribute to up to $2,000 to a spousal IRA, even where the spouse has
little or no earned income. |
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| TEMPORARY ALTERNATIVE MINIMUM TAX
RELIEF |
| The new law
provides some temporary relief for those subject to the alternative minimum
tax. It increases the individual alternative minimum tax exemption amount by
$2,000 (for single taxpayers) and $4,000 for joint filers, for tax years 2001
through 2004. |
| Note:
Due to a quirk in the tax law, an unintended consequence of the reduction in
income tax rates is that more taxpayers will become subject to the alternative
minimum tax. The temporary measure we discuss in this section will provide some
relief. |
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