By Kenneth H. Bridges, CPA, PFS March 2001
As most of you probably are aware, the Economic Growth and Tax Relief Reconciliation Act of 2001 was recently enacted, bringing about significant changes to Federal tax law. Overall, these changes appear to be very favorable for taxpayers. Unfortunately, many of the provisions do not take affect for several years or are gradually phased in over the next several years. Also, most of the favorable changes (including the repeal of the estate tax), will expire after 2010, unless Congress acts to extend them.
The following is a brief description of the changes we believe to be of greatest interest to our clients.
Reduction in Marginal Tax Rates for Individuals – The legislation reduces the lowest rate by creating a new 10% rate bracket below the current 15% rate bracket, effective retroactive to January 1, 2001. The 10% rate applies to the first $6,000 of taxable income for single filers, the first $10,000 for heads of household, and the first $12,000 for joint filers. Since this new rate is five percentage points less than the former lowest rate, and applies retroactively, the effect will be to reduce individual Federal income tax for 2001 by a maximum of $300 for single filers, $500 for heads of household, and $600 for joint filers. Congress chose to implement the new 10% rate bracket by means of a credit, and having the Treasury Department prepay the credit by issuing “advance refund” or “rebate” checks between now and year end. This is designed to provide an immediate stimulus to the economy (the theory being that most people will spend the refund). Also, it is somewhat of a political gimmick. In reality of course, the rebate is just a reduction in the overpayment you would have had at April 15, 2002 or an increase in the tax you will have due at that date.
Of greater significance to most of our clients, the remaining tax rate brackets will also be reduced, starting July 1, 2001. By 2006, when the reduction is completed, the previous rates of 28%, 31%, 36%, and 39.6% will be 25%, 28%, 33% and 35%, respectively. These reductions are phased in gradually over the six-year period. For 2001, the reduction to each rate bracket is only ½%. For 2002 and 2003, the reduction to each rate bracket is one-percentage point below current levels. For 2004 and 2005, another one percentage point is trimmed.
Estate Tax – One of the most hotly-debated issues has been the repeal of the so-called “death tax”. Many had hoped that the estate tax would be immediately repealed by this year’s legislation. Instead, it is repealed effective 2010. And, unless Congress acts to extend or make the repeal permanent, it will automatically be reinstated in 2011. In the meantime the exemption (currently $675,000) will be gradually increased and the maximum rate (currently up to 55%) will be decreased, as follows:
|Calendar Year||Estate and GST* Tax|
|Highest Estate and Gift
Tax Rate (and GST* Tax Rate)
|*“GST” is “generation skipping tax”.|
|**Gift-tax rate equal to highest individual income-tax rate.|
*“GST” is “generation skipping tax”.
**Gift-tax rate equal to highest individual income-tax rate.
It should be noted that the gift tax (similar to the estate tax, but applying to transfers during life), is not being repealed.
Retirement Plans – The legislation makes a number of favorable changes to the rules governing contributions to tax-deferred retirement plans.
Under current law, the maximum that can be contributed to a defined contribution plan is the lesser of 25% of compensation or $35,000. Under the new law, beginning in 2002, the maximum will be the lesser of 100% of compensation or $40,000. Also, the maximum amount of compensation that can be taken into account under a plan will increase from $170,000 to $200,000.
The maximum elective deferral to a 401(k) plan will increase to $11,000 for 2002, and gradually increase to $15,000 over the next five years. The maximum contribution to a SIMPLE plan will increase to $7,000 for 2002, and gradually increase to $10,000 by 2005. The maximum contribution to an IRA will increase to $3,000.
These are but a few of the changes made in the retirement plan area. Additional changes are discussed in the attached website referenced below.
Repeal of Phase-out of Itemized Deductions and Personal Exemptions – Under present law, higher income taxpayers have their itemized deductions and personal exemptions reduced as a result of their income level. These highly unpopular provisions will be gradually eliminated beginning in 2006.
Alternative Minimum Tax Relief – Support has grown for repeal of the increasingly unpopular “alternative minimum tax” which negatively impacts so many of our clients. However, the recently-enacted legislation does not repeal the AMT, and instead only slightly increases the exemption amount (e.g. $49,000 for joint filers and $35,750 for singles versus the current $45,000 and $33,750, respectively). Further, the exemption continues to be subject to phase-out for higher income taxpayers (e.g. beginning at $150,000 for joint filers), so higher income taxpayers will not enjoy any benefit from this change.
Child-Related Provisions – The legislation gradually increases the child tax credit from $500 per child to $1,000 per child. The credit, however, continues to be subject to phase-out for higher income taxpayers (e.g. $110,000 and above for joint filers). Similarly, the adoption credit is increased to $10,000, but is subject to phase-out for those with income in excess of $150,000. The maximum credit percentage for dependent care expenses is increased from 30% to 35% and the eligible amount of expenses upon which the credit can be based is increased from $2,400 to $3,000 (from $4,800 to $6,000 if more than one child). For taxpayers with income in excess of $43,000, the credit percentage will continue to be 20%.
Employers will be permitted a credit of 25% of qualified expenses for employer-provided child care facilities and 10% of qualified expenses for child care resource and referral services, limited to a maximum credit of $150,000 per year.
Marriage Penalty Relief – Married couples frequently pay a higher amount of income tax than would two single individuals with the same amount of combined income. In spite of popular support for elimination of this so-called “marriage penalty”, it has not been eliminated. Instead, a small amount of relief will come beginning in 2005 by virtue of an increase in the amount of the standard deduction for married couples and an expansion of the 15% rate bracket for married couples.
Education Provisions – The new law provides for a new deduction for college tuition, and expands the benefits of education savings accounts, student loan interest deduction, and qualified tuition plans. However, as has frequently been the case with favorable tax provisions enacted over the past decade, these benefits are generally phased out for higher income taxpayers. The education provisions of the legislation are discussed further at the link below.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.