2001
Tax Law Letter
June
2001
Individual
Rate Cuts Phased-in Between Now and 2006
Marriage
Penalty Relief
Phase-outs
for Personal Exemptions and Itemized Deductions Will Gradually Be Repealed
Child
Tax Credit Will Gradually Increase to $1,000
Adoption
Tax Breaks Expanded
Dependent
Care Breaks Expanded
New
and Expanded Education Breaks
Larger
Retirement Account Contributions
Limited
(Very Limited) Alternative Minimum Tax Relief
Estate
Tax Gradually Repealed
Conclusion
The Tax Cut is for real after all! On June 7, 2001,
President Bush signed legislation that significantly reduces individual tax
rates and eventually repeals the federal estate tax. Numerous other breaks are
included as well. This letter is sent to inform you about the major provisions
in the new law and what they mean for you. So let’s get started.
Individual
Rate Cuts Phased-in Between Now and 2006
The new law
eventually reduces the existing 28% rate bracket to 25%, the 31% bracket to
28%, the 36% bracket to 33%, and the 39.6% bracket to 35%. These changes are
not fully phased-in until the 2006 tax year. For this year, the existing rates
are effectively reduced by one half percent (the 28% rate goes to 27.5%, and
so on). The reduced rates will be reflected in revised payroll tax withholding
tables for the second half of this year. For 2002, the rates will drop to 27%,
30%, 35%, and 38.6%, respectively. The 15% rate remains unchanged.
In addition to
reducing the current tax brackets, a new 10% bracket has been created out of a
portion of the current 15% tax bracket. The 10% rate applies to the first
$6,000 of taxable income for singles, the first $10,000 for heads of
households, and the first $12,000 for joint filers. Although the new 10%
bracket is retroactive to January 1 of this year, nearly all taxpayers will
benefit from the lower rate not when they file their 2001 return but by
receiving a refund check from the IRS some time before the end of this year.
Most taxpayers who filed as a single in 2000 will receive $300 checks (5% of
the $6,000 bracket amount now taxed at 10% rather than 15%), those who filed
as heads of households in 2000 will normally receive $500 checks (5% of
$10,000), and joint filers generally will receive $600 checks (5% of $12,000).
Certain taxpayers, such as nonresident aliens and individuals who can be
claimed as a dependent on the return of someone else are not eligible for the
refund checks.
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Marriage
Penalty Relief—Finally!
When both a husband
and wife work, and especially if they each make about the same amount in
income, they typically pay more in income taxes by being married than if they
were single and filing separate returns. In "tax speak" this is
referred to as a marriage penalty.
Starting in 2005, the new law provides marriage penalty
relief to joint filers in the form of an expanded standard deduction amount
and a wider 15% tax bracket. Once the relief is fully phased-in, the standard
deduction for joint filers will equal double the standard deduction for
singles and the upper end of the 15% tax bracket for joint filers will be
twice the upper-end limit for singles.
Although billed as marriage penalty relief, these changes
apply to all couples who file a joint return. Thus, where only one spouse
works, the new law increases the tax advantages of such a couple being married
and filing a joint return rather than being unmarried and filing separately.
Phase-outs
for Personal Exemptions and Itemized Deductions Will Gradually Be Repealed
Under the new law,
the phase-out rule that reduces personal exemption deductions of high-income
taxpayers will eventually be repealed. This favorable change kicks in starting
in 2006 but won’t be fully effective until 2010. Specifically, the limit on
personal exemptions that would otherwise apply under the phase-out rule is
reduced by one-third for tax years 2006 and 2007 and by two-thirds for 2008
and 2009. The phase-out rule is then completely repealed in 2010.
Similarly, the
itemized deductions phase-out rule for high-income taxpayers will gradually be
repealed. The limit on deductions that would otherwise apply under the
phase-out rule is reduced by one-third for tax years 2006 and 2007 and
by two-thirds for 2008 and 2009. The phase-out rule is then completely
repealed in 2010.
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Child
Tax Credit Will Gradually Increase to $1,000
Under the new law,
you are allowed a $600 tax credit in 2001 for each under-age-17 qualifying
dependent child. This is up from $500 last year. The credit then increases to
$700 in 2005, to $800 in 2009, and eventually tops out at $1,000 in 2010.
However as under prior law, the credit is "phased out" starting at
adjusted gross income (AGI) of $75,000 if you file as a single or head of
household and starting at AGI of $110,000 if you file jointly. Thus,
high-income taxpayers will remain ineligible for this credit.
Adoption
Tax Breaks Expanded
The new law
permanently extends the adoption tax credit and increases the maximum credit
amount to $10,000 (up from the current maximum of $6,000 for special needs
children). The starting point for phase-out of the credit is increased to AGI
of $150,000 (up from the current $75,000). Phase-out will be complete at AGI
of $190,000. Similarly, the income exclusion for employer-provided adoption
assistance is increased to $10,000. The starting point for the phase-out of
this benefit is also increased to AGI of $150,000, with phase-out complete
once AGI reaches $190,000. All these changes are effective for the 2002 tax
year.
Dependent
Care Breaks Expanded
The tax credit for
dependent care expenses incurred to allow you to work will be expanded to
cover up to $3,000 of expenses (up from $2,400). If you have two or more
qualifying dependents, the credit will cover up to $6,000 of expenses (up from
$4,800). The maximum credit percentage for low-income taxpayers will be
increased to 35% (up from 30%). However, as under prior law, most taxpayers
will qualify for a only 20% credit, which will translate into a maximum credit
amount of $600 for one qualifying dependent or $1,200 for two or more
qualifying dependents. These changes are effective for the 2003 tax year.
In addition, the
new law establishes an employer tax credit for companies that provide employee
child care and employee child care resource and referral services. This change
is effective in 2002.
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New
and Expanded Education Breaks
The new law
includes several new and expanded tax breaks related to education. First,
beginning next year the maximum annual contribution to education IRAs will be
increased from the current $500 to a much-more-reasonable $2,000 and the AGI
phase-out range that limits education IRA contributions for high-income
taxpayers will be increased to $190,000 to $220,000 for joint filers (up from
the current range of $150,000 to $160,000). In addition, tax-free education
IRA payouts will be allowed for elementary and secondary school expenses,
including those to attend private and religious K–12 schools. Qualifying
expenses include not only tuition, fees, and academic tutoring, but also
uniforms, transportation, and even the cost of computers and related equipment
(plus most software and the cost of providing Internet access) if used by the
student and the student’s family during any of the years the student is in
school.
Beginning next year, payouts from state-sponsored qualified
tuition programs (QTPs) to cover college costs will become tax-free. (Under
prior law, these programs offered tax-deferral benefits, but payouts were
eventually taxed at the student’s rate.) In addition, the new law will
eventually permit private educational institutions to sponsor tax-free QTPs
that offer prepaid tuition credits or certificates. (Unlike state-sponsored
QTPs, however, these private QTPs will not be able to offer college savings
account plans.)
The phase-out rule that limits college loan interest
deductions for high-income taxpayers will be liberalized. Effective next year,
the phase-out range will be between AGI of $50,000 and $65,000 for singles (up
from the current range of $40,000 to $55,000). The phase-out range for joint
filers will be increased to AGI between $100,000 and $130,000 (up from the
current range of $60,000 to $75,000). Under existing law, deductions are only
allowed for 60 month’s worth of interest payments. The new law lifts the
60-month restriction.
The current-law rule allowing tax-free employer
reimbursements for up to $5,250 of an employee’s annual education expenses
has been made permanent. Starting in 2002, tax-free reimbursements for
graduate courses will also be allowed (currently, only undergraduate courses
qualify).
Finally, the new
law establishes a brand-new deduction for college costs. Starting in 2002,
taxpayers will be able to deduct up to $3,000. However, this break is
eliminated for singles with AGI in excess of $65,000 and for joint filers with
AGI above $130,000. For 2004 and 2005, the maximum deduction amount will
increase to $4,000. Also, in 2004 and 2005 singles with AGI between $65,000
and $80,000 will be entitled to a maximum $2,000 deduction. Ditto for joint
filers with AGI between $130,000 and $160,000. Unfortunately, this new break
will expire after 2005 unless Congress takes further action.
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Larger
Retirement Account Contributions
The new law also
includes a number of changes in the retirement plan area. The key point here
is that you (or your employer) will soon be allowed to make bigger
contributions to most types of tax-advantaged retirement accounts. Here are
the specifics.
The maximum allowable annual contribution to IRA accounts
(including Roth IRAs) will gradually be increased to $5,000 in 2008. The limit
for 2002 will be $3,000. Taxpayers age 50 and above will be allowed to
contribute a bit more than the "normal" maximum. For these
taxpayers, the limit for 2002 will be $3,500; increased to $6,000 in 2008.
The maximum allowable annual contribution to 401(k),
403(b), and 457 accounts will gradually be increased to $15,000 in 2006. The
maximum for 2002 will be $11,000.
The maximum allowable annual contribution to SIMPLE
accounts will gradually be increased to $10,000 in 2005 (up from $6,500 for
this year). The maximum for 2002 will be $7,000.
The maximum annual contribution to a defined benefit plan
will be increased to $40,000 (up from $35,000), effective for 2002.
The maximum annual benefit payable from a defined benefit
pension plan will be increased to $160,000 (up from $140,000), effective for
2002.
The maximum annual compensation taken into account in
determining allowable retirement plan contributions will be increased to
$200,000 (up from $170,000), effective for 2002.
Maximum allowable contributions to profit-sharing and stock
bonus plans will be increased to 25% of compensation (up from 15%), effective
for 2002.
Finally, sole
proprietors, partners, LLC members, and more-than-2% shareholder-employees
of Scorporations will be allowed to borrow from their tax-advantaged
retirement accounts (typically under Keogh plans) on the same basis as
garden-variety employees. This change is effective for 2002. However,
borrowing against IRA and SEP accounts will continue to be prohibited, as
under existing law.
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Limited
(Very Limited) Alternative Minimum Tax Relief
To help prevent the
alternative minimum tax (AMT) from eating up all the savings from these
favorable changes to the "regular tax" rules, the AMT exemption is
increased by $2,000 for single filers and by $4,000 for joint filers,
effective for 2001 through 2004. This limited relief will expire after 2004,
unless Congress takes further action.
Estate
Tax Gradually Repealed
A number of
complicated, but generally favorable, changes were made to the federal estate
and gift tax rules. The key point is that the estate tax is scheduled for
complete repeal in 2010 while the gift tax is being retained. Between now and
then the estate tax will continue to exist, but with the expanded exemption
amounts listed below. (The gift tax exclusion will rise to $1 million in 2002
and remain at that level. In 2010 the maximum gift tax rate will drop to the
highest individual income tax rate.)
