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Devilish Details
Tax and Financial News
June 2001
Devilish Details
On May 26, 2001, the United States Congress gave the final nod to a $1.35 trillion tax cut. The cut was passed by a healthy 240-154 margin in the House and 58-33 margin in the Senate. It was also a truly bipartisan bill in which just about everyone got something it wanted. President Bush is expected to sign the bill some time after the Memorial Day Congressional break.
This article will take you through some of the major provisions of the plan, but be careful in you're tax planning. As with so many bills passed by all recent Congresses, the devil is in the details on this bill.
In order for the tax cut plan to meet budgetary needs, Congress set all of these law changes to sunset on December 31, 2010. Translated, this means we will be right back where we started come January 1, 2011. Nowhere is this more apparent than in a review of the Joint Committee on Taxation's (JCT) own numbers. According to the JCT, the first year's tax reduction (including direct refund payments discussed later) will be approximately $74 billion, drop to approximately $38 billion in 2002 and gradually rise to $187 billion in 2010. In 2011, however, the savings will plunge to $130 billion.
On the surface of things, it would seem the American people are being deceived into believing the tax cuts are permanent. This is, however, no different than any of the other tax breaks we have received in the past. Consider the Research and Development Credit that required continual Congressional reauthorization or the Employer paid education benefits. Both expired only a year or several years after their first enactment, but were continually renewed and, thus, became more or less permanent by continual extension. Such is believed to be what will happen to the new laws over time. Only time will be the true judge of what happens.
With the preceding in mind, let's take a look at the details.
Individual Income Tax Rates
The Act, know as "The Economic Growth and Tax Relief Reconciliation Act of 2001" establishes a new 10% bracket for lower income taxpayers to be delivered by means of a cash rebate of up to $300 for single taxpayers, $500 for heads of household and $600 for married taxpayers filing jointly. This will be in lieu of establishing the 10% bracket effective January 1, 2001. Thereafter, tax would be computed using the 10% rate and no credit.
The Act also decreases the maximum tax rate of 39.6% this year to 38.6% in 2001-2003, 37.6% in the years 2004-2005 for years 2006 forward to 35%. The 28%, 31% and 36% tax brackets would decrease in the same manner as the 39.6% rate.
Itemized Deductions
The phase-out of itemized deductions and personal exemptions is repealed under the Act by 1/3 in 2006 and 2007 and 2/3 in 2008-2009. Thereafter, these two limitations would be eliminated.
Childcare credits and Child Tax Credit
Expenses eligible for the Childcare Credit would increase from the current $2,400 in 2001 to $3,000 for 2002 and thereafter. The Child tax credit will gradually increase from $500 per child per year to $1,000 in 2010 and later years. The maximum credit for adopting a child will increase to $10,000 per eligible child.
In addition, the Child Tax Credit will be treated as refundable. This allows low-income taxpayers who previously could not obtain the benefit of the credit to now claim it. It would permanently allow the use of the credit(s) against the Alternative Minimum Tax.
Marriage Tax Penalty Relief
Beginning in 2005, the standard deduction for married couples would gradually increase to where it equaled double the amount of the single taxpayer standard deduction. The Act also gradually increases the amount of income subject to the 15% rate bracket for married couples filing jointly to twice that of single taxpayers beginning in 2005.
Phase-out of the earned income credit will also be expanded for married taxpayers beginning in 2002 and the definition of earned income will be amended to simplify its calculation.
Education Incentives
The limit on contributions to Education IRAs will increase from $500 to $2,000 in 2002 and will also allow for the use of both the HOPE or Lifetime Education credits even if tax-free distributions from an Education IRA are used to pay expenses. The only stipulation is that the credit must be claimed for expenses not paid for by the Education IRA. The phase-out range for utilizing the Education IRA for married taxpayers filing jointly will increase to twice the amount for single taxpayers. Thus, the phase-out range will be $190,000 to $220,000.
One of key aspects of the new law is distributions may be made from Education IRAs for elementary and secondary school expenses - an important aspect of Mr. Bush's plan.
The Act also will allow taxpayers to exclude both principal and interest earned on funds deposited with the so-called prepaid tuition plans offered by qualified education institutions. Previously, income buildup on such plans was taxable when distributed.
Employer-provided educational assistance will be made permanent in 2002 and expenditures for graduate level classes will be permitted.
While there are other miscellaneous provisions in this area, the final key provision is the elimination of deductibility of student loan interest payments for only the first 60 months payments after beginning regular payments. All interest payments will be deductible.
The phase-out range for married taxpayers filing jointly will increase to double the amount for single taxpayers.
Estate Tax Repeal
Estate taxes would be repealed in 2010. Until then, the highest effective rates would be gradually decreased to 45% in 2009 with a $3.5 million exemption.
Retirement Provisions
There are a number of provisions in this area to help people make extra "catch-up" contributions to IRAs, increase the maximum deductible amounts and increase limitations on 401(k) plan contributions. These would all be gradually phased in.
Conclusion
We have but briefly touched on some of the major changes in the tax law due to the Act. For further detail, you can go to the following:
This article will take you through some of the major provisions of the plan, but be careful in you're tax planning. As with so many bills passed by all recent Congresses, the devil is in the details on this bill.
In order for the tax cut plan to meet budgetary needs, Congress set all of these law changes to sunset on December 31, 2010. Translated, this means we will be right back where we started come January 1, 2011. Nowhere is this more apparent than in a review of the Joint Committee on Taxation's (JCT) own numbers. According to the JCT, the first year's tax reduction (including direct refund payments discussed later) will be approximately $74 billion, drop to approximately $38 billion in 2002 and gradually rise to $187 billion in 2010. In 2011, however, the savings will plunge to $130 billion.
On the surface of things, it would seem the American people are being deceived into believing the tax cuts are permanent. This is, however, no different than any of the other tax breaks we have received in the past. Consider the Research and Development Credit that required continual Congressional reauthorization or the Employer paid education benefits. Both expired only a year or several years after their first enactment, but were continually renewed and, thus, became more or less permanent by continual extension. Such is believed to be what will happen to the new laws over time. Only time will be the true judge of what happens.
With the preceding in mind, let's take a look at the details.
Individual Income Tax Rates
The Act, know as "The Economic Growth and Tax Relief Reconciliation Act of 2001" establishes a new 10% bracket for lower income taxpayers to be delivered by means of a cash rebate of up to $300 for single taxpayers, $500 for heads of household and $600 for married taxpayers filing jointly. This will be in lieu of establishing the 10% bracket effective January 1, 2001. Thereafter, tax would be computed using the 10% rate and no credit.
The Act also decreases the maximum tax rate of 39.6% this year to 38.6% in 2001-2003, 37.6% in the years 2004-2005 for years 2006 forward to 35%. The 28%, 31% and 36% tax brackets would decrease in the same manner as the 39.6% rate.
Itemized Deductions
The phase-out of itemized deductions and personal exemptions is repealed under the Act by 1/3 in 2006 and 2007 and 2/3 in 2008-2009. Thereafter, these two limitations would be eliminated.
Childcare credits and Child Tax Credit
Expenses eligible for the Childcare Credit would increase from the current $2,400 in 2001 to $3,000 for 2002 and thereafter. The Child tax credit will gradually increase from $500 per child per year to $1,000 in 2010 and later years. The maximum credit for adopting a child will increase to $10,000 per eligible child.
In addition, the Child Tax Credit will be treated as refundable. This allows low-income taxpayers who previously could not obtain the benefit of the credit to now claim it. It would permanently allow the use of the credit(s) against the Alternative Minimum Tax.
Marriage Tax Penalty Relief
Beginning in 2005, the standard deduction for married couples would gradually increase to where it equaled double the amount of the single taxpayer standard deduction. The Act also gradually increases the amount of income subject to the 15% rate bracket for married couples filing jointly to twice that of single taxpayers beginning in 2005.
Phase-out of the earned income credit will also be expanded for married taxpayers beginning in 2002 and the definition of earned income will be amended to simplify its calculation.
Education Incentives
The limit on contributions to Education IRAs will increase from $500 to $2,000 in 2002 and will also allow for the use of both the HOPE or Lifetime Education credits even if tax-free distributions from an Education IRA are used to pay expenses. The only stipulation is that the credit must be claimed for expenses not paid for by the Education IRA. The phase-out range for utilizing the Education IRA for married taxpayers filing jointly will increase to twice the amount for single taxpayers. Thus, the phase-out range will be $190,000 to $220,000.
One of key aspects of the new law is distributions may be made from Education IRAs for elementary and secondary school expenses - an important aspect of Mr. Bush's plan.
The Act also will allow taxpayers to exclude both principal and interest earned on funds deposited with the so-called prepaid tuition plans offered by qualified education institutions. Previously, income buildup on such plans was taxable when distributed.
Employer-provided educational assistance will be made permanent in 2002 and expenditures for graduate level classes will be permitted.
While there are other miscellaneous provisions in this area, the final key provision is the elimination of deductibility of student loan interest payments for only the first 60 months payments after beginning regular payments. All interest payments will be deductible.
The phase-out range for married taxpayers filing jointly will increase to double the amount for single taxpayers.
Estate Tax Repeal
Estate taxes would be repealed in 2010. Until then, the highest effective rates would be gradually decreased to 45% in 2009 with a $3.5 million exemption.
Retirement Provisions
There are a number of provisions in this area to help people make extra "catch-up" contributions to IRAs, increase the maximum deductible amounts and increase limitations on 401(k) plan contributions. These would all be gradually phased in.
Conclusion
We have but briefly touched on some of the major changes in the tax law due to the Act. For further detail, you can go to the following:
- Estimated Budget Effects of the Conference Agreement for H.R. 1836, prepared by the JCT
- Distribution of Estimated Tax Savings by Taxable Income prepared by the JCT
- Summary of Provisions of H.R. 1836, prepared by JCT
Although the new tax law does provide significant relief to the taxpayer, the presence of sunset provisions for substantially all major provisions of the Act make it treacherous from a planning standpoint and many key provisions do not begin to phase in until after 2005 and 2006. In short - don't expect this to be the final word in taxes over the next four years. Before making any serious long-term plans, give us a call and let us help you decide what is best for you.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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