After 2008, these income ceilings will be adjusted for inflation.  The 15% rate bracket will begin at the end of the 10% bracket and end at the same level as under present law.

Individual taxpayers will also benefit from the new 10% rate in 2001.  Rather than incorporating the 10% rate into the 2001 tax rate schedules, the new law directs the Treasury to mail a "rebate" check to most individual taxpayers who filed a return for 2000, providing an immediate tax benefit.  (For those who didn't file for 2000 or had no or a small tax liability, an adjustment will be made on the 2001 return.)  The "rebate" amounts will be up to $600 for joint filers, up to $500 for heads of households, and up to $300 for single filers and married persons filing separately.

The remaining tax rates 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.  The schedule for these rate reductions is:

Itemized Deduction Reduction Repealed.  Higher income taxpayers who itemize deductions on their federal tax returns must reduce their deductions if adjusted gross income (AGI) exceeds a certain inflation-adjusted threshold ($132,950 in 2001; $66,475 for married persons filing separately).  The new law gradually repeals the itemized deduction reduction.  The otherwise applicable reduction will be reduced by one third for 2006 and 2007, and by two thirds in 2008 and 2009.  Effective for tax years beginning after 2009, the itemized deduction reduction will be repealed.

Personal Exemption Phaseout Repealed.  Personal exemptions for a taxpayer, his or her spouse, and any dependents ($2,900 each for 2001) are reduced by 2% for each $2,500 (or portion thereof) by which AGI exceeds certain thresholds.  (The $2,500 figure is $1,250 for a married person filing a separate return.)  For 2001, the AGI thresholds are $132,950 for single individuals, $199,450 for joint filers, $166,200 for heads of households, and $99,725 for married persons filing separately.  These thresholds are adjusted annually for inflation.

Under the new law, the otherwise applicable exemption phaseout will be reduced by one third in 2006 and 2007 and by two thirds in 2008 and 2009.  After 2009, the personal exemption phaseout will be totally repealed.

Child-Related Provisions
Child Tax Credit.  Before the new law, eligible taxpayers could claim a $500 tax credit (that is, a direct offset against income tax) for each qualifying dependent child under age 17.  Taxpayers whose tax liabilities were not high enough to take full advantage of the credit generally could not receive refunds of any unused credit amounts, with the exception of eligible families with three or more qualifying children.  Moreover, prior law prohibited use of the child tax credit to reduce alternative minimum tax liability after 2001.

Under the new law, the child tax credit is increased to $1,000, phased in over 10 years, starting in 2001.

The new law also makes the child tax credit refundable to the extent of 10% of the taxpayer's earned income in excess of $10,000 (as indexed for inflation after 2001) for tax years 2001 through 2004 (15% after 2004).  Families with three or more children may continue to use the old rules for a refundable child tax credit if that amount is greater than the new credit-refund amount.  And the new law allows the child tax credit to be claimed permanently against the alternative minimum tax for tax years starting after 2001.

Adoption Tax Benefits.  Currently, taxpayers may claim a tax credit for qualified adoption expenses of up to $5,000 a child ($6,000 in the case of a special needs child).  The credit is phased out ratably for taxpayers with $75,000 to $115,000 of AGI.  The credit for non-special needs adoptions was set to expire after 2001. The law also allows, through 2001, an exclusion from income for employer-provided adoption assistance (the dollar limits and phaseout are the same as for the credit).

Effective for years starting after 2001, the credit is permanent for all adoptions, the maximum credit increases to $10,000 per child for all adoptions, and the phaseout starting point becomes $150,000 of AGI.  The law permanently extends the income exclusion for employer-provided adoption assistance and raises the maximum exclusion amount and phaseout range to match the credit.  After 2002, a credit/exclusion can be claimed for a special needs adoption regardless of whether the taxpayer actually has qualified adoption expenses.

Dependent Care Credit.  Current law allows a taxpayer to claim a dependent care credit for a portion of qualifying child or dependent care expenses paid for the purpose of allowing the taxpayer to work.  Generally, to be eligible, the taxpayer must maintain a home for a dependent under age 13, or a spouse or other dependent incapable of self care.  The maximum annual credit is 30% of up to $2,400 of expenses for one qualifying individual and $4,800 for two or more.  The credit percentage is reduced in steps to 20% as AGI increases from $10,000 to over $28,000.

Effective for years starting after 2002, the 30% credit percentage increases to 35% and the maximum amount of eligible expenses rises to $3,000 for one qualifying individual and $6,000 for two or more.  Plus, the credit percentage "phase-down" to 20% will occur when AGI increases from $15,000 to over $43,000.

In a related provision, beginning in tax years starting after 2001, employers may claim a tax credit equal to 25% of qualified expenses for employer-provided child care and 10% of qualified expenses from employer-provided child care resource and referral services, up to a maximum $150,000 credit per tax year.

Marriage Penalty Relief
A married couple may file a joint tax return and be treated as one taxpayer, so that taxes are paid on the couple's total taxable income.  (While a married couple may file separate returns, this usually results in higher taxes than filing jointly.)  A "marriage penalty" exists when the combined tax liability of a married couple filing jointly is greater than the sum of their tax liabilities computed as though they were two unmarried filers.

The new law adds several measures to alleviate the marriage penalty, but not until 2005.

Standard Deduction Increase.  The tax law allows individuals who do not itemize deductions to claim a standard deduction.  The standard deduction available to single filers in 2001 is 60% of the standard deduction that can be claimed on a joint return.  Thus, two unmarried persons have total standard deductions that exceed the standard deduction allowed to a married couple filing jointly.

The new law increases the basic standard deduction for joint filers to twice the basic standard deduction for an unmarried person filing a single return.  The increase is phased in over five years, beginning in 2005, and is fully applicable in 2009 and later years.

Expansion of 15% Bracket.  The new law increases the size of the 15% regular income-tax bracket for joint filers to twice the size of the corresponding 15% rate bracket for an unmarried person filing a single return.  The increase is phased in over four years, starting in 2005.

The new law also makes adjustments to the earned income credit to provide additional marriage penalty relief for lower earners.

Education Provisions
The new law contains several provisions that add to the education incentives provided under current law.

Modification of Education IRAs.  The tax law currently allows a taxpayer to make nondeductible contributions to an Education IRA for the purpose of paying the future higher education expenses (post-secondary tuition, fees, books, supplies, and equipment) of a designated beneficiary.  Annual contributions to all Education IRAs for a beneficiary may not exceed $500 and may not be made after that beneficiary reaches age 18.  The $500 contribution limit is phased out ratably for taxpayers with AGI between $95,000 and $110,000 ($150,000 to $160,000 for joint filers).  Taxpayers with AGI exceeding the higher amount are not allowed to contribute.

Education IRA distributions for qualified higher education expenses are excluded from income.  If distributions are greater than expenses in a year, then a portion of the distribution is subject to income tax plus a 10% additional tax penalty (some exceptions apply).  Distributions generally must be made by the time the beneficiary reaches age 30.

Effective for tax years starting after 2001, the new law:

Qualified Tuition Programs.  Also called college savings plans or "Section 529 plans," these state-sponsored tuition programs offer parents and other taxpayers a tax-favored means of funding a child's future qualified higher education expenses.  Under current law, earnings accumulate tax deferred and generally are taxable to the beneficiary (rather than the parent or other person who established the plan) when funds are distributed to pay expenses or education benefits are received.  The beneficiary (or person allowed to claim the beneficiary as a dependent) may claim a HOPE or Lifetime Learning Credit for the tuition and related expenses paid with the distribution, if otherwise eligible.

For tax years starting after 2001 (unless noted), the new tax law:

Employer-Provided Educational Assistance.  Employer-paid educational expenses are generally deductible by the employer and are excludable from the employee's income, up to $5,250 annually (if certain requirements are met).  The exclusion does not apply to graduate courses and is scheduled to expire with respect to undergraduate courses that start after December 31, 2001.  The new law extends the exclusion to graduate courses and makes the exclusion for undergraduate and graduate courses permanent, effective for courses starting after 2001.

Student Loan Interest Deduction.  Within limits, interest paid on qualified education loans is tax deductible.  The deduction, which may be claimed whether the taxpayer itemizes or not, is allowed for up to $2,500 of interest paid each year during the first 60 months in which interest payments are required.  Voluntary payments of interest do not qualify.  Eligibility for the deduction is phased out for taxpayers with AGI of $40,000 to $55,000 for unmarried taxpayers and $60,000 to $75,000 for joint filers (to be adjusted for inflation after 2002). 

After 2001, the new law repeals the 60-month limit, as well as the restriction that voluntary interest payments are not deductible.  The income phaseout ranges increase to $50,000 to $65,000 for unmarried taxpayers and to $100,000 to $130,000 for married couples filing jointly.

Deduction for Higher Education Expenses.  In general, education expenses are not tax deductible.  (Certain exceptions exist--for example, if the education qualifies as an employee business expense.)  And, while the HOPE and Lifetime Learning Credits are available for qualifying expenses, in some cases a deduction for the expenses would provide a greater tax benefit.

Recognizing this, Congress included in the new law a new deduction for qualified higher education expenses (defined in the same manner as for the HOPE Credit) that are paid during the year.  The deduction may be claimed whether or not the taxpayer itemizes deductions.  However, no education expense deduction may be claimed in a year in which a HOPE or Lifetime Learning Credit has been claimed for the same student.  The maximum amount of the deduction - and the maximum income a taxpayer may have and still claim the deduction - is as follows:

Those with AGI exceeding the maximums (and married-separate filers) may not claim any deduction.  The deduction expires for tax years beginning after 2005.

Estate and Gift Taxes
The current law imposes three federal taxes on transfers of assets from one person to another.  A gift tax is payable by the giver ("donor") of a lifetime gift.  An estate tax is imposed on the estate of a decedent based on the value of the estate's assets.  A generation-skipping transfer (GST) tax applies to lifetime or death-time transfers to a member of a generation more than one generation younger than the person making the transfer.

The estate and gift taxes are unified so that a single graduated tax rate schedule, ranging from 18% to 55%, applies.  In addition, a 5% surtax is imposed on cumulative transfers between $10 million and $17,184,000 to phase out the benefits of the graduated rates.  The GST tax is imposed at a flat rate of 55% and may be owed in addition to other transfer taxes.

A "unified credit" is available to offset gift and estate taxes.  For 2001, the unified credit effectively exempts $675,000 in cumulative lifetime and death-time transfers.  This effective exemption amount is scheduled to increase in steps so that it will be $1 million in 2006.  The GST tax has a separate exemption for cumulative generation-skipping transfers of up to $1,060,000 (in 2001; subject to future inflation adjustments).

The current law also allows a 100% gift-tax and estate-tax marital deduction for qualifying transfers between spouses.  (A special rule applies if the recipient-spouse is not a U.S. citizen.)  Other deductions (e.g., for charitable donations) and credits (e.g., a credit for state death taxes) are also available.

Under present law, if the recipient of a gift later sells the gift property, he or she generally uses the donor's tax basis in determining gain or loss.  (Basis typically represents the property's original cost plus or minus various adjustments required after acquisition.)  Thus, essentially, the donor's basis is "carried over" to the recipient.  This carryover basis, however, generally cannot exceed the asset's fair market value on the date of the gift.

On the other hand, property passing from a decedent's estate generally receives a "stepped-up" basis.  The basis of the asset becomes the fair market value of the asset as of the date of death or the alternate valuation date up to six months after death.  This stepped-up basis allows a beneficiary of an estate who sells the property to avoid tax on any appreciation in the value of the property that occurred before the decedent's death.

The new law overhauls the transfer tax system.  Among the changes are a phaseout and eventual repeal of the estate and GST taxes, revision of the gift-tax rates, and a change in the way the tax basis of inherited assets is figured.

Phaseout and Repeal of Estate and GST Taxes.  Starting in 2002 and through 2009, the top estate- and gift-tax rates will be reduced, and the unified credit effective exemption amount for estate-tax purposes and the GST tax exemption will increase in steps.

In 2002, the 5% surtax and estate- and gift-tax rates in excess of 50% are repealed, and the unified credit exemption amount will increase to $1 million.  (This amount will stay in effect for gift-tax purposes in 2002 and later years.)  The state death tax credit will be reduced by 25% and will continue to be reduced annually until it is repealed in 2005 (to be replaced at that time by an estate-tax deduction for state death taxes).

In 2010, the estate and generation-skipping transfer taxes are repealed.  The top gift-tax rate will be equal to the highest individual income-tax rate (scheduled to be 35%).

The accompanying table shows the exemption increases and the highest rates.

Basis of Property Acquired from a Decedent.  Starting in 2010, the new law repeals the old stepped-up basis rule for death-time transfers and replaces it with a modified carryover basis rule.  In general, the basis of property received from a decedent will be the lesser of (1) the decedent's adjusted basis in the property or (2) the property's fair market value on the date of death.

Starting in 2010, the new law allows an executor or personal representative of an estate to increase (step up) the basis of assets acquired by the beneficiaries at the decedent's death, within certain limits.  Each estate will generally be permitted to increase the basis of assets transferred up to a total of $1.3 million.  Plus, the basis of property transferred to a surviving spouse may be increased by an additional $3 million, so the total step up for assets transferred to a surviving spouse will be as much as $4.3 million.  Both the $1.3 million and $3 million figures will be adjusted for inflation occurring after 2010.

Other Transfer-Tax Provisions.  The new law contains numerous other transfer-tax and related provisions:

IRAs and Pensions
The new law makes numerous changes to the tax rules affecting individual retirement accounts and pension plans.

Maximum IRA Contributions.  In general, there are two types of individual retirement accounts:  the traditional IRA, which provides for tax-deductible contributions (where the taxpayer qualifies) and taxable distributions; and the Roth IRA, which provides for after-tax contributions (again, where the taxpayer qualifies), but allows nontaxable distributions.  An individual may contribute up to $2,000 a year in total to all IRAs owned by that person.

The new law increases the maximum dollar limit for IRA contributions as follows:

Catch-Up IRA Contributions.  Under the new law, individuals who have reached age 50 and who meet the tax law's AGI limits for regular contributions for the year may make additional "catch-up" IRA or Roth IRA contributions, to make up for possible missed retirement savings opportunities earlier in life.  The otherwise maximum IRA contribution annual limit for a person who has reached age 50 by the end of the tax year (before application of the AGI phaseout limits) is increased by $500 for 2002 through 2005 and $1,000 for 2006 and after.

Deemed IRAs under Employer Plans.  Effective for plan years beginning after 2002, if an eligible retirement plan (such as a 401(k) or 403(b) plan) allows employees to make voluntary employee contributions to a separate account that is established within the plan and meets the requirements of either a traditional IRA or Roth IRA, then the account will be deemed a traditional IRA or Roth IRA.  The contributions would be governed by the tax law rules for the type of IRA chosen.

Limits on Contributions to 401(k) and Other Plans.  The new law increases the amounts that may be contributed on a pretax basis to 401(k) salary deferral plans, 403(b) tax-sheltered annuity plans, salary reduction Simplified Employee Pensions (SAR-SEPs), SIMPLE retirement plans, and 457 deferred compensation plans.  The existing limits and new limits are shown in the accompanying table.

The new law also increases the percentage limit (currently 33-1/3% of compensation) for 457 deferred compensation plans to 100% for 2002 and after.

Increase in Plan Contribution and Benefit Limits.  Under current law, overall limits apply to contributions to and benefits funded under tax-qualified retirement plans.  In addition, maximums are imposed on the amount of compensation that may be taken into account in determining contributions and benefits.  The new law makes changes to these limits.

Employer Deduction Limit.  Employer deductions for contributions to tax-qualified retirement plans are subject to limits.  In the case of a stock bonus or profit sharing plan, the deduction limit is 15% of the compensation of employees covered by the plan.  For purposes of the deduction limit, employee elective deferrals to a 401(k) plan are currently counted as employer contributions and, thus, are subject to the limit.

The new law provides that 401(k) elective deferrals are not to be counted as employer contributions subject to the deduction limit, effective for tax years starting after 2001.  Moreover, the 15%-of-compensation limit will rise to 25% for years starting after 2001.

Elective Deferrals as Roth Contributions.  The new legislation allows a 401(k) plan or 403(b) plan to include a "Roth contribution program," effective for tax years starting after 2005.  This program would permit a participant to elect to have all or a portion of the participant's elective deferrals to the plan treated like Roth IRA contributions.  Thus, a designated Roth contribution will not be excludable from the participant's income when made, but, if all requirements are met, a distribution from the Roth contribution program will not be taxed.  The annual dollar limit on designated Roth contributions is the annual limit on elective deferrals, reduced by elective deferrals that are not designated Roth contributions.

Catch-Up Contributions.  The new law allows older individuals to make special catch-up contributions.  In the case of 401(k), 403(b), SIMPLE, SAR-SEP, and 457 plans, an individual who has reached age 50 by the end of the year and who has already made the maximum allowable pretax elective deferral to the plan may make an additional pretax catch-up contribution.  The maximum catch-up contribution is the lesser of (1) an applicable dollar amount (see table) or (2) the participant's compensation less any other elective deferrals for the year.

An employer is permitted--but not required--to make matching contributions with respect to catch-up contributions.  Catch-up contributions are not subject to any other contribution limits or to the otherwise applicable nondiscrimination rules.

Credit for Elective Deferrals and IRA Contributions.  For tax years starting after 2001 and before 2007, the new law provides a nonrefundable credit for contributions made by eligible taxpayers to qualifying retirement plans.  In general, a tax credit of up to $1,000 (i.e., up to 50% of up to $2,000 of contributions) will be available to single taxpayers (or married persons filing separately) with AGI of $25,000 or less, joint filers with AGI of $50,000 or less, and heads of households with AGI of $37,500 or less.  The amount of the credit depends on the taxpayer's AGI and the amount of qualifying contributions.  The credit is in addition to any deduction or exclusion allowed for the contributions.  The credit is available for elective contributions to a 401(k), 403(b), 457, or SIMPLE plan, a SAR-SEP, contributions to a traditional IRA or Roth IRA, and voluntary after-tax contributions to a tax-qualified retirement plan.

Portability of Benefits.  The tax law contains numerous rules that apply when rolling over eligible distributions from one tax-favored retirement plan to another with the purpose of retaining the tax-favored treatment of the money distributed.

Depending on the types of plans involved, the existing rules vary considerably.

Starting with distributions made after 2001, the new law expands the rollover options, offering further incentives for individuals to keep distributed retirement benefits in tax-favored accounts and flexibility as to where money can be rolled over.  Under the new law, eligible rollover distributions from tax-qualified plans, 403(b) annuities, and 457 plans generally may be rolled over to any of the other types of plans (and IRAs) that accept such rollovers.  Note that these plans are not required to accept rollovers.

Other new rollover provisions:

Small Business Credit for Plan Expenses.  The new law provides a tax credit for small businesses that pay expenses for retirement plans.

Small businesses may claim a credit for 50% of the first $1,000 of administrative and retirement-education expenses connected with starting and maintaining a new tax-qualified plan, SIMPLE plan, or SEP during each of the first three plan years.  A small business is defined as one with no more than 100 employees having compensation in excess of $5,000 in the preceding year and with at least one nonhighly compensated employee.  The provision is effective for costs paid or incurred in tax years beginning after 2001, for plans set up after 2001.

Other Pension Changes.  Among other changes to the pension rules, the new law:

Alternative Minimum Tax
Currently, the alternative minimum tax (AMT) is imposed on individuals who have significant income-tax deductions or credits to ensure that a minimum amount of tax is paid.  The law provides an AMT exemption to each taxpayer.  However, the exemption amounts have not been adjusted for inflation and, as a result, increasing numbers of middle-income taxpayers have been hit with the tax.

Beginning in the 2001 tax year through the 2004 tax year, the new law increases the exemption amounts as follows:

Conclusion
The Economic Growth and Tax Relief Reconciliation Act of 2001 offers significant tax reductions for most taxpayers.  But many of those cuts are phased in over a number of years.  And, due to budget limitations, the new law is subject to a "sunset" provision that, without further Congressional action, would cause the law's changes to expire after 2010.  Accordingly, your tax planning - as well as your retirement and estate planning - will probably be more complicated over the next several years.

We would be happy to help you with your planning.  Let our professionals be of assistance to you.

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