Tax relief is on the way

By Steven L. Wiseman, CPA
Chair, MACPA Federal Taxation Committee

On June 7, 2001, President Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 ("the Act"). This law was passed rather expediently by tax legislation standards and fulfills one of the President's major campaign promises.

Before looking at the specifics of the legislation, some general comments are in order. The total tax cut is $1.35 trillion and is aimed primarily at individual taxpayers. It does not contain as many structural changes to the tax code as the 1997 tax law. Many of the major provisions are phased in over the next decade and taxpayers will not see most of the effects in tax year 2001. Finally, to comply with Senate budget rules, the entire act will sunset beginning Jan. 1, 2011.

Discussed below are the major provisions of the Act.

Reduction in tax rates

The Act reduces the current 28 percent, 31 percent, 36 percent and 39.6 percent brackets beginning in 2001. The four rates are reduced to 25 percent, 28 percent, 33 percent and 35 percent, respectively, by 2006 and remain there through 2010.

The 15 percent rate remains the same. However, a new 10 percent rate is created from the bottom of the current 15 percent bracket. The 10 percent bracket amounts are capped at the following: $6,000 for single filers, $10,000 for head of household, and $12,000 for joint returns. These amounts are adjusted upward beginning in 2008 and are adjusted for inflation thereafter.

Rather than taxpayers receiving the benefit of this 10 percent bracket when filing their 2001 tax returns, provision has been made for immediate tax refunds, with checks being mailed to all taxpayers who filed 2000 tax returns. Each taxpayer will receive a check in the amount of the new 10 percent bracket times the rate differential, based on the 2000 tax return (15 percent versus the new 10 percent, or 5 percent). The maximum refund check amounts are $300 (single), $500 (head of household), and $600 (joint). For taxpayers that do not receive the maximum check (e.g., single filer with less than $6,000 of taxable income on 2000 return) and who subsequent qualify for it, a tax credit provision will be available on the 2001 tax return.

Phaseout of itemized deductions and personal exemptions

The itemized deduction and exemption phaseout ranges for high-income taxpayers are increased beginning in 2006 and are fully repealed by 2010. The limitation is reduced by one-third for 2006 and 2007 and by two-thirds for 2008 and 2009.

Child tax and adoption credits

The child tax credit will increase to $600 per child beginning in 2001 and eventually rise to $1,000 by 2010. The phaseout ranges remain the same; however, the credit is now refundable for lower income taxpayers.

The adoption credit for other than special needs children (currently $5,000) is now permanent and increases to $10,000 per eligible child beginning in 2002. The $10,000 maximum is the same for special needs children. The beginning of the phaseout range is increased to $150,000.

Dependent care tax breaks

Beginning in 2003, the maximum amount of expenses eligible for the dependent care credit increases from $2,400 to $3,000 per child (up to two children). Also, the maximum credit increases from 30 percent to 35 percent beginning in 2003, though most taxpayers will continue to receive a 20 percent credit (due to higher income).

The Act contains a new credit for employer-provided child care expenses, beginning in 2002. The credit is 25 percent of such expenses and 10 percent of expenses for child care resource and referral services. The maximum annual credit is $150,000.

Marriage penalty relief

The Act increases the standard deduction on joint returns to be twice that of someone filing single. This is phased in over five years beginning in 2005.

In addition, the 15 percent tax bracket is expanded to twice that of a single filer. This is also phased in over five years beginning in 2005.

Education IRAs

Beginning in 2002, the amount that can be contributed annually to an education IRA is increased from $500 to $2,000 and the adjusted gross income ("AGI") phaseout range is raised. Also, the qualified education expenses that can be paid from these funds will now include qualified secondary and elementary school expenses.

Qualified tuition programs

The Act provides for distributions from a Section 529 to be tax-free if used to pay for qualified education expenses, including the earnings on these funds. This is for tax years beginning after 2001. Also, the definition of qualified tuition program is expanded to include prepaid tuition programs.

Other educational provisions

Beginning in 2002, a new above-the-line deduction is available for qualified tuition and related expenses. For 2002 and 2003 the deduction is for a maximum of $3,000 of expenses, with a phaseout beginning at $65,000 (single filers) and $130,000 (joint filers).

The $5,250 exclusion for employer-provided educational assistance is now permanent and beginning in 2002 will include certain graduate level courses.

The phaseout range for student loan interest is increased to $55,000-$65,000 for single returns and $100,000-$130,000 for joint returns. Also, the limitation on number of months of deductible interest is eliminated beginning in 2002 (currently the first 60 months of the payback period).

IRA contributions

The Act increases the amount of contributions (deductible, nondeductible, and Roth) for IRAs from $2,000 to $3,000 beginning in 2002. The limit then increases to $4,000 in 2005 and $5,000 in 2008, with inflation adjustments thereafter.

Qualified plan contributions

Beginning in 2002, there are various increases to the amounts that can be contributed to retirement plans, including 401(k)s and SIMPLE plans. Also, beginning in 2005, participants in 401(k) and 403(b) plans may treat their elective deferrals as Roth contributions, thereby achieving the same benefits as Roth IRAs.

Other areas of change related to retirement plans are tax credits for contributions, credits for new retirement plan expenses and catch-up contributions. These changes will be covered in a future article.

Alternative minimum tax

For the years 2001 to 2004, the alternative minimum tax exemption increases by $4,000 (joint returns) and $2,000 (all other returns).

Estate tax repeal

The Act gradually repeals the estate and gift tax by 2010 and makes various changes to this tax system until that time. This repeal and related planning ideas will be covered in a future article.

Summary

This article is intended to be an overview of the Act. For more detailed information, please check the MACPA Web site and future issues of The Statement.

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