$1.35. Trillion Tax Cut Passed by Congress

On May 26, 2001 both houses of Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 ( (the "Act") which will enact a 10-year, 1.35 trillion tax cut. President Bush is expected to sign the Act into law this week.

Major  Act provisions include the following:

Tax Brackets Reduced Personal Exemption and Itemized Deduction Phase Out EliminatedChild Care Credit Doubled Marriage Penalty Reduced Savings for Retirement ExpandedDeath Tax Eliminated Impact of the Alternative Minimum Tax ReducedAdoption Credit Expanded Tax Breaks for Education Added

Tax Brackets Reduced - The Act provides three fundamental changes to the individual income tax:

A new 10% tax bracket is created

The top marginal tax bracket is lowered from 39.6% to 35%

Lower marginal tax brackets are reduced by 3% 

Under the Act the top marginal 39.6% rate will be reduced over the next five years to 35%, and the 36%, 31%, and 28% rates will each be reduced by three percent. In addition, the first $12,000 of taxable income will now be taxed at 10%( $6,000 for a singles and $10,000 for heads of households) down from 15%. In 2008, the amount of income taxable at the 10% rate will increase to $14,000 for married couples, and $7,000 for single taxpayers. The amount which qualifies for the 10% rate will remain unchanged for heads of household.

The rate cut is retroactive to the beginning of the year. Instead of receiving the benefit of the 10% bracket in 2001, refund checks will be mailed to taxpayers later this year. The refund checks will be $600 for married couples, $300 for individuals, and $500 for single parents. Refunds will be received based on the last digit of an individuals Social Security number from lowest to highest 

Personal Exemption and Itemized Deduction Phase Out - Under the Act the phase out of personal exemptions that occurs under prior law at higher levels of income would be eliminated starting in 2006. Under the Act, the otherwise applicable personal exemption phase-out is reduced by one-third in taxable years beginning in 2006 and 2007, and is reduced by two-thirds in taxable years beginning in 2008 and 2009.  The provision is fully effective for taxable years beginning after December 31, 2009.

The Act also eliminates the reduction of itemized deductions which impacts taxpayers with higher levels of income. The otherwise applicable overall limitation on itemized deductions is reduced by one-third in taxable years beginning in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009.  The overall limitation is eliminated for taxable years beginning after December 31, 2009.

Child Care Credit Doubled - The Act doubles the child tax credit from $500 to $1,000 per child and allows the credit to be applied against the Alternative Minimum Tax (AMT) on a permanent basis. 

The credit would rise to $600 this year and then increase to $1,000 by the year 2010 according to the following schedule:

In addition the credit is now made refundable to extent of 10% of the taxpayer's earned income over $10,000 for tax years 2001-2004. The $10,000 is indexed for inflation beginning in 2002. In 2005 and thereafter the percentage increases to 15%. 

The Act provides that the refundable portion of the child credit does not constitute income and shall not be treated as resources for purposes of determining eligibility or the amount or nature of benefits or assistance under any Federal program or any State or local program financed with Federal funds.

The Act provides further that the refundable child tax credit will no longer be reduced by the amount of the alternative minimum tax.  In addition, the Act allows the child tax credit to the extent of the full amount of the individual's regular income tax and alternative minimum tax. 

The provision generally is effective for taxable years beginning after December 31, 2000.  The provision relating to allowing the child tax credit against alternative minimum tax is effective for taxable years beginning after December 31, 2001.

Reduces Marriage Penalty - The Act adds provisions designed to counter act  the "marriage penalty". 

First the standard deduction for married couples is to be increased to twice that available for singles. The increase will be gradually take effect between now and 2005, when it will finally be increased to $9,100. 

In addition the 15% income tax bracket is to be broadened to allow more income to be taxed at that rate rather than the 25% level. Under the Act the threshold income level taxed at this level would be increased to $54,100 (from $45,200) by the year 2005.

Further, for married taxpayers who file a joint return, the Act increases the beginning and ending of the earned income credit phase-out by $1,000 in the case of taxable years beginning in 2002-2004; by $2,000 in the case of taxable years beginning in 2005-2007; and by $3,000 in the case of taxable years beginning after 2007.  The $3,000 amount is to be adjusted annually for inflation after 2008.

The Act also simplifies the definition of "earned income" by excluding nontaxable employee compensation from the definition for earned income credit purposes.  The Act repeals the present-law provision that reduces the earned income credit by the amount of an individual's alternative minimum tax.

The Act adopts  a simplified definition of a "child" for purposes of the earned income credit and modifies the present-law tie-breaking rules.  The Act also simplifies the calculation of the earned income credit by replacing "modified adjusted gross income" with "adjusted gross income".

The Act provisions are effective for taxable years beginning after December 31, 2001. 

Savings for Retirement Expanded - The new law will increase the employee contribution limit for 401(k)s and other types of employer-sponsored retirement plans.

The Act also makes other changes to the rules relating to individual retirement arrangements ("IRAs") and qualified pension plans.  Among the changes included in the Act are the following :

(1)   Provisions for expanding coverage, including increased contribution and benefit limits for qualified plans, increases in elective deferral limits, and adding a credit for certain elective deferrals and IRA contributions;

(2)  Provisions to enhance fairness for women, including additional catch-up contributions for individuals over age 50;

(3)  Provisions for increasing portability for plan participants;

(4)  Provisions for strengthening pension security and enforcement; and

(5)  Provisions for reducing regulatory burdens.

The annual contribution limit for 401(k) and 403(b) plans will gradually increase from $10,500 now to $15,000. The contribution limit for section 457 plans, used by state and local government employees, will also increase to $15,000, from $8,500 now.

The contribution limit for SIMPLE plans, offered by smaller employers, will increase from $6,500 now to $10,000 in 2005.

Extra Contributions Allowed for Age 50 and Older

Older workers will be able to contribute more than the normal limits. This provision is intended to allow workers aged 50 and over who haven't saved enough for retirement to make up for lost time and "catch up" on their contributions.

Defined-Benefit Plan Limit

The new law will increase the maximum pension benefit a retiree can receive under a defined-benefit plan from $140,000 a year to $160,000 a year beginning in 2002.

Defined-Contribution Plans

Under current law, the overall amount that can be added each year to defined-contribution plans (including employer and employee contributions) is limited to the lesser of 25 percent of compensation or $35,000. The new law will increase the percentage of compensation limit to 100 percent and the dollar limit to $40,000 beginning in 2002.

Employer Deduction For Profit-Sharing, Stock Bonus Plans

The limit on deductions  for employer contributions to a profit-sharing or stock bonus plan will  increase  from 15 percent to 25 percent of compensation beginning in 2002.

Compensation Limit

The maximum amount of compensation that can be taken into account for purposes of determining contributions and benefits under a retirement plan will increase from $170,000 to $200,000 in 2002.

Elimination of the Death Tax - The Act repeals the federal estate and the generation-skipping transfer taxes by 2010.  Those taxes are to be phased out between 2002 and 2009 and finally repealed in 2010. The gift tax is modified but not repealed by the Act. In addition, in 2004, the family-owned business deduction is repealed. 

Between now and 2010, the estate tax exemption would increase from $675,000, to $3.5 million by 2009, and the top marginal rate would be lowered to 50% in 2002, and gradually to 45% by 2008. 

The gift tax is not repealed under the Act. Instead a $1,000,000 lifetime gift tax exemption is allowed beginning in 2002. The top marginal gift tax rate will decline at the same rate as the estate tax. In 2010, after estate tax repeal, the top gift tax rate will be the same as the top income tax rate of 35%. Also beginning in 2010, except as provided in regulations, a transfer to trust will be treated as a taxable gift, unless the trust is treated as wholly owned by the donor or the donor's spouse under the grantor trust provisions of the Code

After repeal of the estate tax, the basis of property acquired from a decedent would be the lower of FMV at date of death or the decedent's adjusted basis in the property. Recapture potential would carry over to the person acquiring the property. Each estate would receive $1.3 million of basis to be added to the carryover basis of any one or more of the assets held at death (the amount would be only $60,000 for estates of nonresident aliens). An estate would receive additional basis equal to the decedent's unused capital loss carry forwards and unused NOL carry forwards. Estates would be allowed an additional $3 of basis to be allocated among assets passing to a surviving spouse who is a U.S. citizen. These additional basis amounts will not be permitted to increase any asset's basis above its Fair Market Value (FMV) on the date of death. The amounts would be inflation-indexed after 2009.The exclusion of gain on the sale of a decedent's principal residence would be extended to heirs.

Under the Act, from 2002 through 2004, the State death tax credit allowable under present law is reduced as follows:  in 2002, the State death tax credit is reduced by 25 percent (from present law amounts); in 2003, the State death tax credit is reduced by 50 percent (from present law amounts); and in 2004, the State death tax credit is reduced by 75 percent (from present law amounts).  In 2005, the State death tax credit is repealed, after which there will be a deduction for death taxes (e.g., any estate, inheritance, legacy, or succession taxes) actually paid to any State or the District of Columbia, in respect of property included in the gross estate of the decedent.  

Amendments also included in the Act would : (1) expand the estate tax rule for conservation easements, (2) modify the generation-skipping tax rules, and (3) expand the availability of installment payment relief.

Alternative Minimum Tax - The individual exemption now available for the AMT would be increased by $4,000 on a joint return and $2,000 for unmarried filers by 2004. 

Other Tax Credits and Tax Breaks

Adoption Credit -  The maximum credit is increased to $10,000 per eligible child, including special needs children.  A $10,000 credit is provided in the year a special needs adoption is finalized regardless of whether the taxpayer has qualified adoption expenses.  The beginning point of the income phase-out range is increased to $150,000 of modified adjusted gross income.  Finally, the adoption credit is allowed against the alternative minimum tax permanently.

The Act permanently extends the exclusion from income for employer-provided adoption assistance.  The maximum exclusion is increased to $10,000 per eligible child, including special needs children.  In the case of a special needs adoption, the exclusion is provided regardless of whether the taxpayer has qualified adoption expenses.  The beginning point of the income phase-out range is increased to $150,000 of modified adjusted gross income.  The Act agreement generally is effective for taxable years beginning after December 31, 2001.  The provisions that extend the tax credit and exclusion from income for special needs adoptions regardless of whether the taxpayer has qualified adoption expenses are effective for taxable years beginning after December 31, 2002.

Expansion of Dependent Care Tax Credit - The Act increases the maximum amount of eligible employment-related expenses from $2,400 to $3,000, if there is one qualifying individual (from $4,800 to $6,000, if there are two or more qualifying individuals) and increases the maximum credit from 30 percent to 35 percent.  The Act modifies the phase-down of the credit so that it begins at $15,000 of adjusted gross income.  The provision is effective for taxable years beginning after December 31, 2001.

Tax Credit for Employer-Provided Child Care Facilities - Under the Act, taxpayers receive a tax credit equal to 25 percent of qualified expenses for employee child care and 10 percent of qualified expenses for child care resource and referral services.  The maximum total credit that may be claimed by a taxpayer cannot exceed $150,000 per taxable year.  The provision is effective for taxable years beginning after December 31, 2001

Tax Breaks for Education -

Contribution limits for education savings accounts are expanded from $500 to $2,000, and  tax-free distributions for certain elementary, secondary, and after-school expenses are now allowed.

Distributions from qualified state tuition plans used for qualified higher education expenses are tax-free beginning in 2002.

The Act makes the exemption for employer provided educational assistance permanent and make it available for graduate study.

The Act eliminates the provision that restricts the deductibility of student loan interest to interest incurred during the first 60 months the interest is required. The Act also increases the income level at which the interest payments are deductible. The current phase out range of  $40,000 of AGI to $55,000,  is increased to $50,000 and $65,000 for single filers. For married taxpayers the phase out  is increased from $60,000 to $75,000 to a phase out range of $100,000 to $130,000. 

The Act implements a new tax deduction for college expenses which may be claimed in lieu of the Hope Scholarship tax credit. The new deduction allows taxpayers with AGI of up to $65,000 ($130,000) on a joint return) to claim a maximum deduction of $3,000, per year.

In 2004, and 2005, taxpayers with adjusted gross incomes up to $65,000 ($130,000, on a joint return, can claim a deduction of up to $4,000. Filers with incomes up to $80,000 ($160,000) on a joint return can claim up to $2,000. The deduction will lapse by 2005. 

Sunset Provision

The legislation's provisions expire on December 31, 2010.

Warning -

For many individuals and families residing in high income tax states, additional AMT will reduce the tax cut available. This will especially impact those making between $75,000 and $625,000 per year. Contact your accountant or tax preparer for details.