I.       The Sunset Provision

 

·       Most of the tax cuts contained in the Act are phased in over ten-year period.  As originally designed, these tax cuts were to have become permanent as of 2011.  However, the “Byrd Rule” - a budgetary procedure - requires any Act that would alter revenue beyond a 10-year period to receive 60 votes in the Senate.  Because the Act did not receive the required 60 votes, it will expire as of December 31, 2010, and the current tax laws will be reinstated.

 

·       The Act’s Sunset Provision ensures further Congressional action in this area.  It is likely the Act will be modified significantly in the near future, with proposals amending the Act having already been offered for debate.  Most experts agree that the Act, as it is currently written, will not survive intact.

 

II.     Estate and Gift Tax Provisions

 

A.     Repeal of the Estate Tax and the Generation-Skipping Transfer Tax, Reduction in the Gift Tax

 

Current Law. 

 

·       Most transfers to a spouse qualify for the unlimited marital deduction, regardless of value.

 

·       The unified credit allows a taxpayer to transfer assets, either during life (by gift) or at death, with a fair market value of $675,000 to beneficiaries, other than a spouse, free of federal estate or gift tax.

 

·       The unified credit is scheduled to increase, in phases, to $1,000,000 by the year 2006. 

 

·       An additional tax, called the generation-skipping transfer tax (the “GST tax”), is imposed on certain transfers to persons who are more than one generation younger than the donor, to the extent the transfers exceed the GST tax exemption which is currently $1,060,000.  The GST tax rate is a flat 55% rate.

New Law.

 

1.     As the table below illustrates, the top estate and gift tax rates will be reduced and the unified credit effective exemption amount will continue to increase in steps.

 

 

Calendar       Year	Estate Tax    Exemption	Gift Tax    Exemption	GST Tax Exemption	Highest Estate and Gift Tax Rate (and GST Tax Rate)
1997	$600,000	$600,000	$1,000,000	55%*
1998	$625,000	$625,000	$1,000,000	55%*
1999	$650,000	$650,000	$1,010,000	55%*
2000	$675,000	$675,000	$1,030,000	55%*
2001	$675,000	$675,000	$1,060,000	55%*
2002	$1 million	$1 million	Indexed for inflation	50%
2003	$1 million	$1 million	Indexed for inflation	49%
2004	$1.5 million	$1 million	$1.5 million	48%
2005	$1.5 million	$1 million	$1.5 million	47%
2006	$2 million	$1 million	$2 million	46%
2007	$2 million	$1 million	$2 million	45%
2008	$2 million	$1 million	$2 million	45%
2009	$3.5 million	$1 million	$3.5 million	45%
2010	Tax repealed	$1 million	Tax Repealed	35%**
2011	$1 million	$1 million	$1,060,000 plus inflation adjustment	55%
* Additional 5% surcharge applies to estates between $10 million and $17.184 million. **After 2010, the gift-tax rate will be equal to the highest income-tax rate for individuals.

 

 

2.     State Death Tax Credit. Beginning on January 1, 2002, the state death tax credit allowable to estates for purposes of calculating the amount of federal estate tax due will be phased out:

 

a.     For estates of decedents dying in 2002, the state death tax credit will be 75% of its current amount.

 

b.     For estates of decedents dying in 2003, the state death tax credit will be 50% of its current amount.

 

c.      For estates of decedents dying in 2004, the state death tax credit will be 25% of its current amount.

 

d.     The state death tax credit will be repealed for estates of decedents dying after December 31, 2004.

 

3.     QFOBIs. In 2004, the deduction for qualified family owned business interests is repealed.

 

Planning Notes:

 

1.     Assuming a taxpayer lives until January 1, 2002, the unified credit for estate and gift tax purposes will be $1.0 million unless the person dies within a seven (7) year period beginning January 1, 2004 and ending January 1, 2011.

 

2.     Wills and trusts should be reviewed if they utilize formula bequest language such as the phrase “the maximum amount that can pass estate tax free under the federal estate tax laws” or “that amount necessary to reduce the federal estate tax to zero.”

 

3.     The key to planning in the future is flexibility; including, but not limited to, the following:

 

a.     The use of qualified disclaimers to fund estate tax sheltered trusts.

 

b.     The use of powers of appointment.

 

4.     As the unified credit increases over the phase-in period, it will become increasingly important to insure that assets are properly titled; particularly in cases of estates above $2.0 million on or after January 1, 2004.

 

5.     Due to the sunset provision, clients should continue to consider gifting programs using the annual gift tax exclusion and the $1.0 million gift tax exemption to the extent such gifts do not create current gift tax liabilities:

 

a.     In large estates, life time gifts will reduce overall transfer taxes if estate tax laws are reinstated.

 

b.     Lifetime gifts can shift taxable income to donees in lower income tax brackets; a planning opportunity that will receive a lot of attention if estate taxes are permanently repealed.

 

c.      For individuals with assets which will not receive a full step-up in basis at death (due to the limitations set forth in the new law),  there is one less disadvantage to gifting during life.

 

6.     Individuals should consider revising their advance medical directives to take into account the possibility of prolonging life when a person has a terminal illness and it would be in the best financial interests of the family to do so.

 

B.     The New Basis Rules

 

Current Law.

 

1.     Carryover Basis for Gifted Assets.  Assets that are gifted during life retain the donor’s basis (“carryover basis”), not to exceed the asset’s fair market value as of the date of the gift.

 

2.     Step-up in Basis at Death.  Assets passing from a decedent’s estate receive a “stepped-up” basis equal to the fair market value as of date of death (or as of the alternate valuation date).   This stepped-up basis eliminates capital gain on any appreciation in the value of the property that occurred after the acquisition of the asset and prior to the decedent’s death.

 

New Law.  Starting in 2010, the stepped-up basis rule for transfers at death is repealed and replaced 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 as of date of death.  However, subject to a number of limitations, a stepped-up basis in assets of the decedent is still permitted.

 

1.     Recipients of property “owned by the decedent” at death will generally be entitled to an aggregate basis increase (to date of death value) of $1.3 million (as adjusted for inflation after 2010).

 

a.     The surviving spouse of the decedent will be entitled to an additional aggregate basis increase of $3 million (as adjusted for inflation after 2010) for “qualified spousal property” owned by the decedent at death. Qualified spousal property is property that would currently be entitled to the unlimited marital deduction under IRC §2056 and is either outright transfer property, or qualified terminable interest property (property which passes from the decedent and in which the surviving spouse has a qualified income interest for life).

 

b.     In the case of a decedent who was neither a U.S. resident nor a U.S. citizen, the aggregate basis increase is limited to only $60,000 (as indexed for inflation beginning in year 2010).

 

2.     The following rules are applicable in determining whether property was “owned by the decedent” at death:

 

a.     The decedent will be treated as having owned 50% of any property jointly owned by the decedent and his or her surviving spouse.

 

b.     For property held as joint tenants with rights of survivorship with a non-spouse and which was acquired for consideration, the decedent will be considered to have owned only that portion of the property which reflects his or her pro rata portion of the consideration furnished to acquire the property.

 

c.      If the decedent acquired property by gift (or any transfer without consideration) during a 3 year period ending on the date of his or her death, the decedent will not be treated as having owned the property unless it was acquired from his or her spouse and the decedent’s spouse did not acquire the property for no consideration within said 3 year period.

 

d.     The decedent will be considered to have owned all property transferred by him or her to a qualified revocable trust (i.e. grantor trust) during life.

 

e.     The income tax exclusion of up to $250,000 of gain on the sale of a principal residence is available to the decedent’s estate or beneficiary where the decedent’s pre-death use and ownership qualifies for the exclusion pursuant to IRC §121.

 

f.      All items of income in respect of a decedent (IRD) are not eligible for basis step-up.

 

3.     Information Reporting

 

a.     If the fair market value of property acquired from a decedent exceeds the $1.3 million basis increase amount, or the decedent received gifts of appreciated property within three years of the decedent’s death that are not eligible for the basis increases, the executor must provide the following information to the IRS:

 

(1)    The name and social security number of the recipient of such property;

 

(2)    An accurate description of such property;

 

(3)    The adjusted basis of such property in the hands of the decedent and its fair market value at the time of death;

 

(4)    The decedent’s holding period for such property;

 

(5)    Sufficient information to determine whether any gain on the sale of the property would be treated as ordinary income;

 

(6)    The amount of basis increase allocated to the property under I.R.C. §1022(b) (the $1,300,000 increase) or I.R.C. §1022(c) (the $3,000,000 increase for transfers to a surviving spouse); and

 

(7)    Such other information as the Secretary may by regulations prescribe.

 

b.     Within 30 days of filing the estate income tax return, the executor must furnish the same information to each beneficiary to the extent it pertains to property received by such beneficiary.

 

c.      Within 30 days of filing a gift tax return, each recipient of a gift must receive a copy of the information included in the return with respect to the gift.

·       Phase-Out for Upper Income Families.  The credit is phased-out ratably for taxpayers with modified adjusted gross income between $40,000 and $50,000 for single filers ($80,000 to $100,000 for joint filers). 

 

·       Election.  The taxpayer must elect to take either the HOPE Scholarship credit, the Lifetime Learning credit or the education income exclusion (for distributions from Education IRAs).  A taxpayer cannot claim two or more of these benefits in any one taxable year.

 

B.     Lifetime Learning Credit

 

Current Law

 

·       Amount of Credit.  20% of the first $5,000 of qualified tuition expenses paid after June 30, 1998 and prior to January 1, 2003, and 20% of the first $10,000 of qualified tuition expenses paid during a calendar year thereafter.  The credit is available for qualified tuition expenses incurred with respect to undergraduate or graduate level and professional degree courses, and any course taken to acquire or improve job skills.

 

·       Eligible Students.  A taxpayer can claim the credit for qualified tuition expenses incurred for the education of the taxpayer, the taxpayer’s spouse or any dependent of the taxpayer.  A student who is claimed as a dependent on a parent’s return cannot claim the credit on his or her own return.

 

·       Qualified Tuition Expenses include tuition and fees for books, supplies, or equipment used in a course of study but only if the fee must be paid to the eligible educational institution for the enrollment or attendance of the student at the institution.

 

·       Phase-Out for Upper Income Families.  The credit is phased-out ratably for upper income taxpayers with modified adjusted gross incomes between $40,000 to $50,000 for single filers ($80,000 to $100,000 for joint filers). 

 

·       Election.  The taxpayer must elect to take either the HOPE Scholarship credit, the Lifetime Learning credit or the education income exclusion (for distributions from an Education IRA).  A taxpayer cannot claim two or more of these benefits in any one taxable year.

 

C.     Education IRAs

 

Current Law.

 

·       Contributions.  An individual taxpayer may make a nondeductible contribution to an Education IRA for the purpose of paying for “qualified higher education expenses” of a designated beneficiary.  Annual contributions cannot exceed $500, may not be made after the beneficiary reaches age 18 and must be made on or before December 31st of each year.  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).  A 6% excise tax applies to contributions made by anyone to an Education IRA in the same year in which a contribution is made by anyone to a state tuition program qualified under Section 529 of the Code (hereinafter referred to as a “Section 529 Plan”) on behalf of the same beneficiary.

 

·       Qualified Higher Education Expenses are defined as tuition, fees, books, supplies and equipment required for the enrollment or attendance of a designated beneficiary at an eligible education institution; and room and board to the extent of the minimum room and board allowance as determined by the institution for federal financial aid purposes (and only so long as the beneficiary is enrolled at least half-time in a degree, certificate or other program).  Beginning in 2002, “room and board” will include the greater of (1) the minimum room and board allowance as determined by the institution for federal financial aid purposes, or (2) the actual invoice amount charged a student for on-campus housing.  Beginning in 2002, qualified higher education expenses also include the expenses for special needs services for a special needs beneficiary if the expenses are incurred in connection with the beneficiary’s enrollment or attendance at an eligible education institution.  Qualified higher education expenses include contributions to a Section 529 Plan for the benefit of the same designated beneficiary.  Therefore, it is possible to “rollover” an Education IRA to a Section 529 Plan.

 

·       Distributions.  Distributions to the designated beneficiary for qualified higher education expenses are excluded from income.  If distributions are greater than expenses in a year, the excess is subject to income tax plus an additional 10% tax penalty (some exceptions apply).  The income exclusion is not available in any year in which the HOPE Scholarship credit or Lifetime Learning credit is claimed.  Amounts remaining in the account must be distributed within 30 days after the beneficiary reaches age 30 or within 30 days after the death of the beneficiary.

 

D.     New Laws Applicable to Hope Scholarship Credit, Lifetime Learning Credit and Education IRAs

 

1.     The annual contribution limit for Education IRAs is increased to $2,000 per designated beneficiary. 

 

2.     Individual calendar year taxpayers now have until April 15th of the following year to make contributions to an Education IRA for the previous calendar year.

 

3.     For Education IRAs, the contribution phaseout for joint filers is increased to AGI between $190,000 and $220,000.  The contribution phaseout for single filers is not changed.

 

4.     The age 18 restriction on contributions to Education IRAs and the age 30 restriction on distributions from Education IRAs are eliminated in cases where a beneficiary has “special needs.”  The term “special needs” will be defined in future regulations.

 

5.     For Education IRAs, the definition of qualified education expense is expanded to include elementary and secondary school (K-12) expenses; namely, tuition, fees, books, supplies, tutoring, room and board, special needs services, transportation, uniforms, computers and extended day programs incurred in connection with the enrollment or attendance of the beneficiary at a public, private or religious school.

 

6.     The Act clarifies that corporations and other entities may make contributions to Education IRAs.

 

7.     The Act allows a taxpayer to claim a HOPE Scholarship credit or Lifetime Learning credit for a taxable year and to exclude from gross income amounts distributed from an Education IRA on behalf of the same student as long as the distribution is not used for the same educational expenses for which a credit is claimed.

 

8.     The Act eliminates the 6% excise tax on contributions to Education IRAs made in the same year contributions are made to a qualified tuition program on behalf of the same beneficiary.  Consequently, for tax years beginning after 2001, contributions may be made to both an Education IRA and a qualified tuition program on behalf of the same beneficiary.

 

B.     State Tuition Programs (Section 529 Plans).

 

Current Law.

 

·       Contributions.  After-tax (non-deductible) contributions can be made to a Section 529 Plan to fund a designated beneficiary’s future “qualified higher education expenses.”  Contributions either purchase “tuition credits” or are allocated to a savings account for the beneficiary.  The plan must be sponsored by a state. 

 

·       Distributions.  Earnings accumulate tax-deferred and are taxable to the beneficiary (rather than to the person who contributed to the plan) when distributed.  The beneficiary may claim a Hope Scholarship or Lifetime Learning Credit for the tuition and related expenses paid with the distribution.

 

·       Qualified Higher Education Expenses are defined as tuition, fees, books, supplies and equipment required for the enrollment or attendance of a designated beneficiary at an eligible education institution, and room and board (so long as the beneficiary is enrolled at least half-time).  Room and board expense is limited to the minimum room and board allowance as determined by the institution for federal financial aid purposes if the beneficiary is living on campus; $2,500 if the beneficiary is living off-campus; and $1,500 if the beneficiary is residing at home with his parent or guardian.

 

·       Contribution Limitations.  Unlike Education IRAs, there is no limit to the amount of contributions that can be made to a tuition program in any given year, and there are no adjusted gross income phase-out limitations associated with qualified tuition programs.  However, total contributions may not exceed the amount determined by actuarial estimates that is necessary to pay tuition, required fees and room and board expenses of the designated beneficiary for five years of undergraduate enrollment at the highest cost institution allowed by the program.  Thus, all state-sponsored Section 529 Plans have different limits.

 

·       Contributions in Excess of the Annual Gift Tax Exclusion.  If a taxpayer’s contributions to a Section 529 Plan on behalf of a single designated beneficiary during any one taxable year exceed the annual exclusion amount, the taxpayer may elect to take into account the amount of the contributions ratably over the five‑year period beginning with that taxable year. However, this treatment is only available with respect to contributions up to five times the exclusion amount available in the calendar year of the contribution. Any excess may not be taken into account ratably and is treated as a taxable gift in the calendar year of the contribution.

 

·       Age Limitation on Contributions and Distributions.  Unlike an Education IRA, there are no age limitations preventing contributions (i.e. after age 18) or requiring distributions (i.e. at age 30).  A contributor can continue to make contributions to a qualified tuition program on behalf of a beneficiary no matter what age the beneficiary is.  The beneficiary is not required to take complete distribution of funds remaining in the program after attaining a certain age.  Planning Note - A person may establish and/or contribute to a Section 529 Plan on which he is the designated beneficiary.

 

·       Changing the Designated Beneficiary.  The designated beneficiary of a plan can be changed so long as the new beneficiary is a member of the original beneficiary’s family.  "Member of the family" means: (1) a son or daughter, or a descendant of either; (2) a stepson or stepdaughter; (3) a brother, sister, stepbrother, or stepsister; (4) the father or mother, or an ancestor of either; (5) a stepfather or stepmother; (6) a son or daughter of a brother or sister; (7) a brother or sister of the father or mother; (8) a son‑in‑law, daughter‑in‑law, father‑in‑law, mother‑in‑law, brother‑in‑law, or sister‑in‑law; or (9) the spouse of the designated beneficiary or the spouse of any individual described in (1) through (8), above.

 

·       Plan Rollovers.  Currently, a designated beneficiary’s interest in one state’s Section 529 Plan can be rolled over to a different state’s Section 529 Plan only if the designated beneficiary is being changed (and only once every 12 months).

 

New Law.

 

·       Effective for tax years starting after 2001. 

 

·       Allows public and private educational institutions to sponsor Section 529 programs.  Programs sponsored by educational institutions can only offer “tuition credit” plans, and cannot offer “savings account” plans.

 

·       Distributions Excluded from Income.  Distributions or educational benefits received from a Section 529 plan are excluded from the beneficiary’s income (starting in 2002 for state programs and in 2004 for programs maintained by educational institutions) as long as the distribution is used exclusively for qualified higher education expenses of the designated beneficiary or is a rollover distribution.   After 2003, there will be an additional 10% tax penalty on Section 529 Plan distributions included in the beneficiary’s income unless this distribution is made (1) on account of the death or disability of the designated beneficiary, or (2) on account of the receipt of a scholarship by the designated beneficiary to the extent the amount of the distribution does not exceed the amount of the scholarship. 

 

·       The beneficiary cannot claim a HOPE Scholarship or Lifetime Learning credits for expenses paid with a tax-free distribution.  However, as with distributions from an Education IRA, a taxpayer can claim a HOPE Scholarship or Lifetime Learning credit for a taxable year and to exclude from gross income amounts distributed from a Section 529 Plan on behalf of the same student as long as the distribution is not used for the same educational expenses for which a credit is claimed.

 

·       Rollovers.  The Act allows rollovers from one Section 529 Plan for the benefit of a designated beneficiary to another Section 529 Plan for the benefit of the same designated beneficiary (but only once every 12 months).

 

 

 

C.     Employer-Provided Educational Assistance.

 

Current Law.

 

·       Employer-paid educational assistance (up to $5,250 annually) is deductible by the employer and excluded from the employee’s income.  The deduction does not apply to graduate courses.  The deduction is scheduled to expire December 31, 2001.

 

·       Education Assistance is defined as the payment, by an employer, of expenses incurred by or on behalf of an employee for education of the employee (including, but not limited to, tuition, fees, and similar payments, books, supplies, and equipment), and the provision, by an employer, of courses of instruction for such employee (including books, supplies, and equipment).  Education assistance does not include payment for, or the provision of, tools or supplies which may be retained by the employee after completion of a course of instruction, or meals, lodging, or transportation; and does not include assistance with graduate course expenses.

 

New Law.

 

·       The $5,250 annual deduction and exclusion is extended to graduate courses and is made permanent.

 

 

D.     Student Loan Interest Deduction.

 

Current Law.

 

·       An individual taxpayer may deduct up to $2,500 of interest paid on qualified educational loans.  The loan must have been incurred by the taxpayer to pay qualified higher education expenses.  For example, a parent who pays his child’s student loan cannot take the interest as a deduction because the parent did not incur the debt.  The deduction is allowed only for interest paid during the first 60 months of repayment in which interest payments are required.  Voluntary payments of interest do not qualify.  The deduction may be claimed whether or not the taxpayer itemizes deductions.  The deduction is phased out ratably for individual taxpayers with AGI between $40,000 to $55,000 ($60,000 to $75,000 for joint filers).  No deduction is allowed to an individual if that individual is claimed as a dependent on another taxpayer's return for the taxable year.  In addition, a married taxpayer is allowed to claim the deduction only if the taxpayer and the taxpayer's spouse file a joint return.

 

·       "Qualified higher education expenses" include the cost of attendance (generally, tuition, fees, room and board, and an allowance for books, supplies, transportation and miscellaneous expenses of the student) at an eligible educational institution.

 

New Law.

 

·       The Act repeals the limit on the number of months during which interest paid on a qualified education loan is deductible.  Accordingly, beginning in 2002, interest paid on student loans beyond the initial 60-month period of repayment is now deductible if the other requirements are satisfied.

 

·       Beginning in 2002, voluntary interest payments are deductible.

 

·       The phaseout range is increased for individual taxpayers to AGI between $50,000 to $65,000 ($100,000 to $130,000 for joint filers).

 

E.     Deduction for Higher Education Expenses.

 

Current Law.

·       Generally, education expenses are not deductible unless they can be classified as another otherwise allowable expense (e.g., a business expense).

 

New Law.

 

·       Beginning in 2002 and continuing through 2005, there will be a temporary, limited deduction for qualified tuition expenses.  The deduction will be ratably phased out as follows:

 

Year	Maximum Deduction	Income Limit (AGI)
2002-2003	$3,000	Not exceeding $65,000 ($130,000 for joint filers)
2004-2005	$4,000     $2,000	Not exceeding $65,000 ($130,000 for joint filers)   Over $65,000 ($130,000 for joint filers) but not exceeding $80,000 ($160,000 for joint filers)

 

·       Qualified Tuition Expenses include tuition and fees for books, supplies, or equipment used in a course of study but only if such fees are paid to the eligible educational institution for the enrollment or attendance of the student at the institution.

 

·       The deduction may be taken whether or not the taxpayer itemizes deductions.  No deduction is allowed in a year in which a HOPE Scholarship or Lifetime Learning credit is taken.  The deduction expires for tax years after 2005.

 

IV.    Child-Related Provisions

 

A.     Child Tax Credit.

 

Current Law.

 

·       Currently, a taxpayer may take a $500 tax credit (direct offset against income tax) for each qualifying dependent child under age 17.  If the taxpayer does not have a tax liability that is sufficient to fully utilize the credit, he may not receive a refund of the unused credit amount unless he has three or more qualifying children (in which case the refund is limited to the amount by which the taxpayer’s social security taxes exceed the taxpayer’s earned income credit).  After 2001, the child tax credit cannot be used to reduce alternative minimum tax liability.

 

·       Limitation of Credit Based on AGI.  The child tax credit begins to phase out when modified adjusted gross income reaches $110,000 for joint filers, $55,000 for married taxpayers filing separately and $75,000 for single taxpayers.  The credit is reduced by $50 for each $1,000, or fraction thereof, of modified AGI above the threshold.

 

New Law.

 

·       Beginning in 2001, the child tax credit gradually increases to $1,000 over a ten year period as follows:

 

Calendar Year	Credit Amount per Child
2001-2004	$600
2005-2008	$700
2009	$800
2010 and after	$1,000

 

·       For tax years 2001 through 2004, any unused child tax credit is refundable to the extent of 10% of the taxpayer’s earned income in excess of $10,000 The $10,000 is indexed for inflation beginning in 2002.  For tax years after 2004, the percentage is increased to 15%.  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 amount calculated under new rules.

 

·       The child tax credit can be used to offset alternative minimum tax for tax years starting after 2001.

 

B.     Adoption Tax Benefits.

 

Current Law.

 

·       Taxpayers may claim a tax credit for qualified adoption expenses of up to $5,000 per 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 (for joint or single filers).  The credit for non-special needs children is set to expire after 2001. 

 

·       An exclusion from income for employer-provided adoption assistance (with dollar limits and phaseouts identical to the credit) is also scheduled to expire after 2001.

 

New Law.

 

·       Effective for tax 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 income exclusion for employer-provided adoption assistance is made permanent (the maximum exclusion amount and phaseout range are increased to match those for the credit).

 

·       After 2002, a credit/exclusion can be claimed for a special needs adoption regardless of whether the taxpayer actually had qualified adoption expenses.

 

C.     Dependent Care Credit.

 

Current Law.

 

·       Taxpayer may 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. 

 

·       To be eligible, the taxpayer must maintain a home for a child under age 18, or a spouse or other dependent incapable of self care. 

 

·       The maximum credit is 30% of up to $2,400 of expenses for one dependent and $4,800 for two or more dependants. 

 

·       The 30% applicable percentage is reduced by one percentage point for each $2,000, or fraction thereof, by which the taxpayer's AGI (whether single or married) exceeds $10,000. However, the applicable percentage is never reduced to less than 20%. Accordingly, for taxpayers with AGI in excess of $28,000, the applicable percentage rate is fixed at 20%.

 

New Law.

 

·       Beginning in 2002, the 30% credit percentage is increased to 35% and the maximum amount of eligible expenses rises to $3,000 for one qualifying dependent and $6,000 for two or more.  The credit percentage phase-down to 20% occurs when AGI increases from $15,000 to over $43,000.

 

·       Beginning in 2001, employers may claim a tax credit equal to 25% of qualified expenses for employer-provided child care resource and referral services, up to a maximum of a $150,000 credit per tax year.

 

V.      Marriage Penalty Relief

 

Current Law

 

·       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.  This occurs, in part, because various limitations and allowances allowed for single filers are only partially increased, not doubled, for joint filers.

 

    Calendar Year 2001

Filing Status	Standard Deduction	Top of 15% Bracket
Single	$4,550	$27,050
Married filing jointly	$7,600	$45,200
Married filing separate	$3,800	$22,600

 

New Law

 

·       The marriage penalty is alleviated (not necessarily eliminated) beginning in 2005, by increasing the standard deduction and expanding the 15% tax bracket for married couples filing joint returns.

 

·       The standard deduction (taken when taxpayer does not itemize) for a married couple filing a joint return is gradually increased to twice the basic standard deduction for an unmarried individual filing a single return.  The basic standard deduction for a married taxpayer filing separately continues to equal one-half of the basic standard deduction for a married couple filing jointly.

 

·       The size of the 15% regular income-tax rate bracket for a married couple filing a joint return is gradually increased to twice the size of the corresponding rate bracket for an unmarried individual filing a single return. 

 

·       The following table shows how the standard deduction and the 15% tax rate bracket for joint filers gradually reaches twice that for single filers over the phase-in period:

 

Calendar Year	Joint Return Standard Deduction as % of Single Return Standard Deduction	Top of 15% Joint Bracket as a % of Top of 15% Single Bracket
2001 to 2004	167%	167%
2005	174%	180%
2006	184%	187%
2007	187%	193%
2008	190%	200%
2009 and after	200%	200%

 

 

VI.    Individual Income Tax Rate Reductions

 

A.     Rate Reductions.

 

Current Law.

 

·       There are currently five (5) regular income tax rates: 15%; 28%; 31%; 36% and 39.6%.

 

New Law.

 

·       A new 10% tax rate is established as follows:

 

Filing Status	For 2002-2007, Taxable Income up to:	For 2008 and after*, Taxable Income up to:
Single	$6,000	$7,000
Head of Household	$10,000	$10,000
Married - Joint	$12,000	$14,000
Married - Separate	$6,000	$7,000
*After 2008, amount of income subject to 10% rate will be adjusted annually for inflation.

 

·       Rebates.  Instead of applying the new tax rate for 2001 tax year, the new 10% rate is incorporated in the form of an income tax rebate - up to $600 for joint filers, up to $500 for heads of households and up to $300 for single filers or married filing separately - which is being mailed to taxpayers during 2001.  The rebates are based on year 2000 tax returns.

 

·       The remaining tax rates are gradually reduced as follows:

 

 

	2001	2002-2003	2004-2005	2006 and after
28% rate reduced to:	27.5%	27%	26%	25%
31% rate reduced to:	30.5%	30%	29%	28%
36% rate reduced to:	35.5%	35%	34%	33%
39.6% rate reduced to:	39.1%	38.6%	37.6%	35%

 

 

B.     Reduction of Itemized Deductions Repealed.

 

Current Law.

 

·       Itemized deductions must be reduced if AGI exceeds certain thresholds. 

 

·       The AGI thresholds for 2001 are: $132,950 for single filers, joint filers, and heads of households; and $66,475 for married persons filing separately.  The thresholds are indexed for inflation.

 

·       Itemized deductions, other than deductions for medical expenses, investment interest, and casualty, theft, or wagering losses, are reduced by 3% of the amount of AGI in excess of the thresholds.

 

New Law.

 

·       The reduction of itemized deductions is gradually repealed as follows:  Otherwise applicable reduction will be reduced by one-third for 2006 and 2007; by two-thirds for 2008 and 2009; and will be repealed for tax years beginning after 2009.

 

 

 

 

C.     Personal Exemption Phaseout Repealed.

 

Current Law.

 

·       The personal exemptions allowed for the taxpayer, his spouse and descendants ($2,900 each for 2001) are phased out ratably for taxpayers with AGI over specified thresholds.

 

·       The AGI thresholds for 2001 are: $132,950 for single filers, $199,450 for joint filers, $166,200 for heads of household, and $99,725 for married persons filing separately.  The thresholds are adjusted for inflation.

 

·       The otherwise allowable personal exemptions are reduced by 2% for each $2,500 (or portion thereof) by which AGI exceeds the threshold for single filers, joint filers and heads of households.  The $2,500 figure is $1,250 for a married person filing separately. 

 

·       The deduction for personal exemptions is reduced to zero if AGI exceeds:  $255,450 for single filers, 321,950 for joint filers, $288,700 for heads of household, and $160,975 for married persons filing separately.

 

 

New Law.

 

·       The personal exemption phaseout is gradually repealed.  The otherwise applicable personal exemption phaseout will be reduced by one-third for 2006 and 2007; by two-thirds for 2008 and 2009; and will be repealed for tax years beginning after 2009.

 

 

C.     Individual AMT Relief.

 

Current Law.

 

·       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 as follows: $33,750 for single filers and heads of households, $45,000 for joint filers and $22,500 for a married person filing jointly.  These exemption amounts have not been adjusted for inflation and, as a result, increasing numbers of middle-income taxpayers have been subject to the tax.

 

·       The AMT affects individuals with AMT adjustments and preference items which exceed the AMT exemptions.

 

·       The most common AMT adjustment items are several itemized deductions that, although deductible for regular income tax purposes, are not deductible for AMT purposes, including: state and local income taxes, real estate taxes, personal property taxes, miscellaneous itemized deductions and investment interest.  Other adjustments include refunds of state or local income taxes included on line 10 of your Form 1040 and adjustments for beneficiaries of trusts and estates, as reported on the beneficiary’s Form K-1, line 9.

 

·       The most common AMT preference items are: income from the exercise of incentive stock options, the difference between depreciation for AMT purposes and depreciation for regular income tax purposes, tax-exempt interest from private activity bonds and the difference in income from passive activities as calculated for AMT purposes versus regular tax purposes.

 

·       A taxpayer calculates his or her AMT as follows:

 

1.  Start with your regular taxable income (line 37 from Form 1040);

 

2.  Increase or decrease by amount of adjustment items and preference items for AMT

 

3.  Adjusted minimum taxable income (AMTI) equals Item 1 plus or minus Item 2 above.

 

4.  Reduce AMTI by the AMT exemption amount.

 

5. Tentative minimum tax (TMT) equals 26% of first $175,000 of the amount in Item 4 ($87,500 for married filing separately), plus 28% of the amount in Item 4 in excess of $175,000.

 

6.  AMT equals the excess of the TMT over the regular tax.

 

 

New Law.

 

·       For tax years beginning after December 31, 2001 and beginning before January 1, 2005, although the AMT rates remain the same, the AMT exemption amount is increased as follows:

 

Filing Status	Current AMT Exemption	New AMT Exemption
Married filing jointly	$45,000	$49,000
Head of household	$33,750	$35,750
Single	$33,750	$35,750
Married filing separately	$22,500	$24,500

 

 

 

VII.   IRAs and Employer-Sponsored Retirement Plans

 

A.     Dollar Limits on Annual IRA Contributions.

 

Current Law

 

·       An individual taxpayer can contribute a total of $2,000 to all IRAs (both traditional and Roth) owned by that individual.

 

New Law

 

·       The maximum dollar limit for IRA contributions increases to $3,000 for 2002 through 2004, $4,000 for 2005 through 2007, and $5,000 for 2008. After 2008, the dollar limit will be adjusted for inflation in $500 increments.

 

·       Individuals who are age 50 or older may make a “catch-up” contribution in addition to the maximum annual contributions discussed above.  The otherwise maximum contribution limit (see above) is increased by $500 for 2002 through 2005, and $1,000 for 2006 and thereafter.

 

B.     Dollar Limits on Individual Contributions to Employer-Sponsored Plans.

 

Current Law.

 

·       An individual taxpayer can contribute a total of $10,500 to 401(k) salary deferral plans, 403(b) tax-sheltered annuity plans, and salary reduction Simplified Employee Pensions (SAR-SEPs); a total of $6,500 to SIMPLE retirement plans; and a total of $8,500 to 457 deferred compensation plans.

 

New Law

 

·       Beginning in 2002, the contribution limits are gradually increased as follows:

 

Employer Retirement Plan Maximum Contribution Limits
Year	401(k)/403(b) Plans & SAR-SEPS	SIMPLE Plans	457 Plans
Current	$10,500	$6,500	$8,500
2002	$11,000	$7,000	$11,000
2003	$12,000	$8,000	$12,000
2004	$13,000	$9,000	$13,000
2005	$14,000	$10,000	$14,000
2006 and after	$15,000	$10,000	$15,000
All limits are adjusted for inflation after being fully phased in.

 

 

·       Like the new IRA rules, individuals age 50 and older, and who have already made the maximum allowable pretax elective deferral to the plan, may make an additional “catch-up” contribution.  The maximum catch-up contribution is the lesser of (1) an applicable dollar amount (see table below) or (2) the participant’s compensation less any other elective deferrals for the year.

Employer Retirement Plan Catch-up Contribution Limits For Individuals Age 50 and Older
Year	401(k)/403(b) Plans & SAR-SEPS	SIMPLE Plans	457 Plans
2002	$1,000	$500	$1,000
2003	$2,000	$1,000	$2,000
2004	$3,000	$1,500	$3,000
2005	$4,000	$2,000	$4,000
2006 and after	$5,000	$2,500	$5,000
All limits are adjusted for inflation in 2007 and thereafter.

 

·       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 (discussed below) or to otherwise applicable nondiscrimination rules.

 

 

C.     Overall Limits on Contributions to Employer-Sponsored Plans.

 

Current Law.

 

·       The dollar limits discussed above are the maximum contributions an employee may make to an employer-sponsored retirement plan.  In addition, maximums are imposed on the amount of compensation that may be taken into account in determining contributions and benefits.  The new law increases these limits.

 

New Law.

 

·       Section 457 plans: Currently, employee contributions cannot exceed 33 1/3% of compensation.  New law increases percentage to 100%.

 

·       Defined contribution plans (i.e., 401(k) and profit-sharing plans): Currently, annual additions (including employee and employer contributions and forfeitures) cannot exceed 25% of compensation (up to a maximum of $35,000).  Beginning in 2002, the dollar limit will increase to $40,000 and, in subsequent years, will be adjusted for inflation in increments of $1,000.  Also beginning in 2002, the percentage limit will increase to 100% of compensation.

 

·       Defined-benefit plans: Currently, the maximum annual benefit that can be funded under a defined-benefit pension plan is the lesser of 100% of average compensation or $140,000.  Beginning in 2002, the dollar amount will increase to $160,000.

 

·       The amount of a participant’s compensation that can be taken into account under a qualified defined benefit or defined contribution plan rises from $170,000 for 2001 to $200,000 for 2002 and thereafter.  This amount will be adjusted for inflation in $5,000 increments.

 

D.     Interplay Between IRAs and Employer-Sponsored Retirement Plans

 

New Law.

 

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

 

·       Beginning in 2005, a 401(k) plan or 403(b) plan may include a “Roth contribution program” allowing the participant to elect to have all or a portion of the participant’s elective deferrals to the plan treated like Roth IRA contributions.  Participants who make the election will be taxed currently on the amount treated as a Roth plan contribution.  Qualified distributions from a participant’s Roth contribution account will be       tax-free.

 

 

E.     New Rollover Provisions.  Beginning in the year 2002, the following new rollover rules apply:

 

1.     Pre-tax amounts held in Traditional IRAs may be rolled over tax free into qualified employer sponsored retirement plans (such as a 401(k), 403(b) or 457 Plans) in which the person participates.  In addition, a beneficiary who inherits an IRA from a deceased spouse may roll over that IRA into the employer sponsored plan in which the beneficiary participates.

2.     After tax contributions to qualified employer sponsored retirement plans may be rolled over into another qualified plan or into a Traditional IRA.

 

3.     Eligible distributions from a qualified employer sponsored retirement plan can be rolled over into another qualified plan.  In addition, a beneficiary who receives a distribution from a deceased spouse’s qualified plan may roll over the distribution into the qualified plan in which the beneficiary participates.

 

 

F.      Credit for Elective Deferrals and IRA Contributions.

 

New Law.

 

·       For tax years starting after 2001 and before 2007, there is a nonrefundable credit for elective contributions made to 401(k), 403(b), 457 or SIMPLE plans, SAR-SEPs, and traditional or Roth IRAs, and for voluntary after-tax contributions to tax-qualified retirement plans.

 

·       The credit is in addition to any deduction or exclusion allowed for the contributions. The credit is calculated as a percentage of contributions made.  The maximum contribution eligible for the credit is $2,000.  The rate of the credit is based on AGI as follows:

 

Joint Filers	Heads of Household	All Other Filers	Credit Rate
$0-$30,000	$0-$22,500	$0-$15,000	50%
$30,000-$32,500	$22,500-$24,375	$15,000-$16,250	20%
$32,500-$50,000	$24,375-$37,500	$16,250-$25,000	10%
Over $50,000	Over $37,500	Over $25,000	0%

 

·       For purposes of calculating the credit, the amount of any contribution eligible for the credit is reduced by taxable distributions received by the taxpayer and his or her spouse from any IRA (tradition or Roth) or any other qualified retirement plan during the tax year for which the credit is claimed, the two tax years before the year the credit is claimed, and during the period after the end of the tax year and before the due date for filing the taxpayer’s return.

 

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