Recent Tax Law Changes
Your Initial Financial Plan:
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Print Out The Eight Step Checklist to Keep Track of Your Progress
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Step 1: Calculate Your Financial APGAR Score
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Step 2: Put Together Your "Ow-Ow" (Net Worth) Statement
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Step 3: Prepare Your Monthly Cash Flow Budget
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Step 4: Set Your Savings and Debt Reduction Goals
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Step 5: Project If You're Saving Enough for Retirement
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Step 6: Work Through a Tax Projection (to Avoid Any Surprises Next April 15th)
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Step 7: Review Your Life and Disability Insurance Needs
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Step 8: Have an Attorney Draft Certain Essential Documents
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The Economic Growth and Tax Relief Reconciliation Act of 2001 was passed by Congress on May 26, 2001, and signed into law by President Bush on June 7, 2001. The new tax law provides $1.35 trillion of tax cuts over the coming decade. As you do your tax planning, here are the major provisions of which you'll want to be aware.
REDUCED TAX RATES
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Retroactive to January 1, 2001, a new 10% tax rate will apply to the first $6,000 of taxable income for single individuals, $10,000 for heads of household, and $12,000 for married couples filing jointly. To stimulate the economy, the savings resulting from taxing this income at 10%, rather than the previous 15%, will be returned to taxpayers in the form of rebate checks. The Treasury estimates that about 95 million rebate checks will be sent to taxpayers by October 1 (somewhat later for those who filed late or extended their 2000 income tax returns). Based on their 2000 taxable income, single filers will receive up to $300, heads of household up to $500, and couples up to $600.
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The tax rates above 15% will drop by 1%, effective July 1, 2001. They will drop an additional 1% in 2004 and again in 2006. For 2006 and later years, the tax brackets (currently 15%, 28%, 31%, 36% and 39.6%) will be reduced to 10%, 15%, 25%, 28%, 33%, and 35%.
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Currently, taxpayers lose the benefit of personal exemptions once their income reaches certain levels. In 2001, this applies to single individuals whose adjusted gross income (AGI) exceeds $132,950 and married couples whose AGI exceeds $199,450. The phase-out of the personal exemptions for higher-income taxpayers will be gradually repealed beginning in 2006.
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The limitation on itemized deductions for higher-income taxpayers, which can result in their losing up to 80% of their itemized deductions, will be gradually repealed starting in 2006. This year, you begin to lose out on your itemized deductions once your AGI exceeds $132,950.
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For the years 2001 through 2004, the alternative minimum tax (AMT) exemption will be increased by $2,000 for single individuals and by $4,000 for married couples filing joint returns.
CHILDREN
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The child tax credit, which is currently equal to $500 per child under the age of 17 (subject to certain income limitations), will double by 2010, increasing according to the following schedule:
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2001 – 2004 |
$600 |
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2005 – 2008 |
$700 |
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2009 |
$800 |
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2010 and later |
$1,000 |
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The dependent care tax credit will be increased beginning next year. The new law increases the maximum amount of allowable dependent care expenses from $2,400 to $3,000 for one qualifying individual and from $4,800 to $6,000 for two or more qualifying individuals.
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The adoption credit is permanently extended and increased to $10,000, effective in 2002. The exclusion from income for employer-provided adoption assistance is made permanent and increased to $10,000, effective in 2002.
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The cost of employer-provided child care facilities will be eligible for a tax credit of 25% starting in 2002. The maximum credit is $150,000 per year, so now may be a good opportunity to convince your employer to provide an in-house daycare center.
MARRIAGE PENALTY RELIEF
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Under the current tax rules, married couples comprised of two working spouses generally pay more in taxes than if they had remained single. To provide some relief, the new law gradually increases the standard deduction for married filing jointly to twice the standard deduction of single filers, beginning in 2005. In 2001, the standard deduction for a single individual is $4,550 while the standard deduction for a married couple is only $7,600.
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Also beginning in 2005, the 15% tax bracket for joint filers will be gradually expanded to double the 15% bracket for single filers. In 2001, single individuals are taxed at a rate of 15% on the first $27,050 of taxable income while the 15% bracket for married couples ends at $45,200.
EDUCATION
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Starting in 2002, the income phase-out ranges for the student interest deduction will be increased to $50,000 - $65,000 for single individuals and $100,000 - $130,000 for married couples. Plus, the rule limiting the deduction to the first 60 months of loan repayment will be eliminated.
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Next year the rules governing education IRAs will be modified. The annual contribution limits will increase from $500 to $2,000, and education IRA funds may be used to pay for elementary and secondary school expenses as well as higher education costs. More taxpayers will qualify to make contributions since the income phase-out range for married taxpayers filing jointly will increase to $190,000 - $220,000. (Currently, the phase-out range for education IRAs is $150,000 - $160,000.)
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Qualified tuition programs are expanded to include private higher education institutions as well as state-sponsored ones. In addition, qualified distributions taken from state-sponsored tuition programs after 2001 will be tax-free. (Under the current rules, the distributions would be taxed at the child's rate.) After 2003, this tax-free status applies to distributions from nonstate programs as well.
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Beginning in 2002, Hope and lifetime learning tax credits can be claimed in the same year as education IRA distributions are taken, as long as different expenses are covered by each.
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The income exclusion for employer-provided education assistance is made permanent and, starting next year, is extended to cover graduate as well as undergraduate education.
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In 2002 and 2003, taxpayers will be allowed to deduct qualified higher education expenses in arriving at their adjusted gross income. The maximum deduction is $3,000 per year and is permitted only if taxpayer income does not exceed $65,000 for singles or $130,000 for joint filers. The deduction increases to a maximum $4,000 for 2004 and 2005. In 2004 and 2005, taxpayers whose income exceeds $65,000 ($130,000 joint) but does not exceed $80,000 ($160,000 joint) will be entitled to a deduction of up to $2,000 for higher education expenses. The deduction for higher education expenses ends after 2005.
SAVING FOR RETIREMENT
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The contribution limit for individual retirement accounts (IRAs) gradually increases from the current $2,000 limit to $5,000 according to the following schedule:
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2002 – 2004 |
$3,000 |
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2005 – 2007 |
$4,000 |
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2008 and later |
$5,000 |
The contribution limit will be adjusted for inflation after 2008. Plus, from 2002 through 2006, lower-income taxpayers (single individuals whose AGI is less than $25,000 or married couples whose AGI is less than $50,000) may qualify for a tax credit ranging from 10% to 50% of the amount they contribute to a retirement plan.
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Employee contribution limits to 401(k) and 403(b) plans will increase gradually from the current maximum of $10,500 to $15,000. The limit will be $11,000 in 2002; and will increase by $1,000 each year until it reaches $15,000 in 2006. The law also creates Roth-type 401(k)s beginning in 2006.
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Employee contribution limits to SIMPLE IRA plans will increase as well from the current maximum of $6,500 to $10,000. The limit will be $7,000 in 2002; and will increase by $1,000 each year until it reaches $10,000 in 2005, and then will be indexed for inflation.
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Catch-up contributions will be allowed for individuals who are 50 or older. From 2002 through 2005, these taxpayers can contribute an additional $500 to their IRAs. Beginning in 2006, this additional contribution limit increases to $1,000. Higher catch-up contributions are permitted for other retirement plans.
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Small businesses who establish a retirement plan after December 31, 2001 are allowed a tax credit equal to 50% of the cost of setting-up and administering the new plan. The credit can be taken on up to $1,000 of expenses for each of the first three years of the plan.
ESTATE TAX
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Effective for 2002, the estate tax rates will decrease, and the amount exempt from tax will increase over the next ten years, according to the following schedule:
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Year |
Exemption Amount |
Top Tax Rate |
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2002 |
$1 million |
50% |
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2003 |
$1 million |
49% |
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2004 |
$1.5 million |
48% |
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2005 |
$1.5 million |
47% |
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2006 |
$2 million |
46% |
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2007-2008 |
$2 million |
45% |
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2009 |
$3.5 million |
45% |
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2010 |
Estate tax repealed |
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It should be noted that even though all of the law's provisions are not fully phased in until 2010, the Act contains a sunset provision rescinding the entire law in 2011 unless a future Congress acts to extend it.
This summary gives general information on the major provisions in the new law. If you have questions about how the new law will affect you, please contact a tax professional.