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Key Changes in the Economic Growth and Tax Relief Reconciliation Act of 2001

After months of Congressional debate, the tax relief package entitled the Economic Growth and Tax Relief Reconciliation Act of 2001 has become law. The Act’s centerpieces are marginal income tax rate cuts, marriage-penalty relief, phase-down and eventual repeal of the estate tax, and a doubling of the child tax credit. The Act also increased incentives for retirement and education savings, and makes some temporary adjustments to the alternative minimum tax. Here’s a summary of the major tax changes contained in the Act. Please contact us if you would like to discuss how these changes affect your personal and business situation.

Tax rate reduction. The Act cuts individual income taxes across the board, but the cuts are phased in gradually through 2006. A new 10% bracket applies to the first $6,000 of taxable income for singles, $10,000 for heads of household, and $12,000 for married joint filers. For 2001, most individuals will get the benefit of this new bracket in the form of tax rebate checks beginning in July. In addition, tax rates higher than 15% will be passed down. For 2001, the old rates of 28%, 31%, 36% and 39.6% each drop a half of a percentage point; by 2006, they will have dropped in stages to 25%, 28%, 33%, and 35%, respectively.

The overall limit on itemized deductions (which causes loss of up to 80% of certain itemized deductions) and the phaseout of personal exemptions for higher income taxpayers will be gradually repealed starting in 2006, in effect lowering marginal tax rates for affected taxpayers.

The AMT exemption amount for married couples filing joint returns has been increased by $4,000 ($2,000 for singles and married couples filing separately) for 2001 through 2004. After 2004, the AMT exemption amounts will return to the levels in effect for 2000 unless Congress does something to change it.

Marriage-penalty relief. Marriage penalty relief will not start to take effect until 2005. Relief will come in the form of increases in the standard deduction for joint filers, as well as an expansion of the 15% bracket for married couples to twice the amount of the 15% bracket for singles.

Estate tax repeal. From 2002 through 2009, estate and gift tax rates will be reduced, with the top rate gradually falling from the current 55% rate to 45%. In addition, the current $675,000 amount that is exempt from estate taxes will rise to $1 million in 2002, $1.5 million in 2004, $2 million in 2006, and $3.5 million in 2009 (the lifetime gift exclusion remains at $1 million).

The estate tax and the related generation-skipping transfer (GST) tax will be fully repealed in 2010. The gift tax will not be repealed, however, and gifts above the $1 million exemption will be subject to a 35% maximum rate.

As noted above, the estate and generation-skipping transfer taxes will be repealed after 2010. After repeal, the basis of assets received from a decedent generally will carry over from the decedent, rather than being stepped-up to date-of-death value as under current law. Heirs will instead have to determine the cost of each asset in the estate at the time it was acquired by the person who died, perhaps decades earlier. However, a decedent’s estate will be able to increase the basis of assets transferred by up to $1.3 million, and, for assets transferred to a surviving spouse, by an additional $3 million. The executor will be able to elect the assets that will receive the basis increase.

Please visit our summary of planning opportunities that arise as a result of these estate tax changes.

Education incentives. A wide array of changes are designed to assist taxpayers meet education costs. These include:

Education IRAs expanded—starting 2002, the annual contribution limit to education IRAs is increased from $500 to $2,000 and these accounts are expanded to cover costs associated with primary and secondary school, and other school-related expenses.

Qualified tuition programs expanded—Tax-free distributions from State plans will be allowed, starting in 2002. Private institutions will be allowed to offer prepaid tuition plans, tax-deferred in 2002, with tax-free distributions beginning in 2004.

Employer-provided education assistance—The exclusion for up to $5,250 a year of employer-provided benefits is made permanent, and extended to graduate courses beginning after 2001.

Student loan interest deduction—After 2001, the phaseout ranges for eligibility for the deduction are increased, and the 60-month limit on interest deductibility is repealed.

Deduction for higher education expenses—Taxpayers (even those who don’t itemize) within certain income ranges can deduct college tuition expenses, up to $3,000 in 2002 and 2003, and up to $4,000 in 2004 and 2005.

National Health and Armed Forces scholarships—Amounts awarded after 2001 are tax-free, without regard to any service obligation by the recipient, but not for amounts received by students for regular living expenses, including room and board.

More details on these education initiatives are available below.

IRA and pension provisions. There are a wide variety of changes designed to encourage retirement savings. These include:

IRA contribution limits—The annual contribution limit for IRA contributions increases to $3,000 for 2002 to 2004, $4,000 for 2005 to 2007, and $5,000 for 2008 and later years.

Catch-up contributions—Individuals age 50 or older can make additional catch-up IRA contributions of $500 for 2002 to 2005 and $1,000 for 2006 and later years.

Qualified plan limits—There are many favorable changes, including generous increasing in many of the contribution and benefit limits.

Larger elective deferrals—The maximum annual elective deferral to 401(k) plans, 403(b) annuities, and salary reduction SEPs will rise from the current $10,500 to $11,000 in 2002, and then in $1,000 annual increments until it reaches $15,000 in 2006. The maximum contribution to a SIMPLE plan will rise from $6,500 to $7,000 in 2002, and thereafter at a rate of $1,000 a year until it reaches $10,000 in 2005.

Additional "catch-up" contributions—The dollar limits on elective deferrals are increased further for individuals who are 50 or older; the additional amount is $1,000 for 2002, $2,000 for 2003, $3,000 for 2004, $4,000 for 2005, and $5,000 or 2006 and later years. Different catch-up contribution amounts will be allowed to those in SIMPLE plans.

Credit for low-and middle-income savers—The Act creates a nonrefundable credit for low-and middle-income savers of up to 50% of contributions to employer plans or IRAs, in addition to any deduction or exclusion that would apply.

More details on the retirement plan changes are available here.

Child tax credit. The current $500 maximum credit per child increased to $600 for 2001 and then gradually climbs to $1,000 for 2010. In addition, the credit now will be refundable for many low-income taxpayers and is permanently allowed against the AMT.

Dependent care credit. Starting in 2003, more child-care expenses will qualify for the dependent care credit and the maximum credit rate will increase from 30% to 35%. The maximum credit will increase to $1,050 for one child and to $2,100 for two or more. The phase-down of the credit will also be modified: The maximum 35% credit rate will be reduced, but not below 20%, by 1 percentage point for each $2,000 (or fraction thereof) of AGI above $15,000. As a result, more individuals will qualify for more than the minimum credit.

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Education Incentives in the Economic Growth and Tax Relief Reconciliation Act of 2001

The newly enacted Act contains a wide array of tax law changes designed to increase incentives for education savings and to assist taxpayers in paying the costs of education. To inform you of the new rules in this area, here’s an overview of the major changes.

Education savings accounts. Beginning in 2002, the annual per-child contribution limit for education IRAs increases from the current $500 to $2,000 per year. Expenses that can be paid from these accounts will be expanded to include elementary (including kindergarten) and secondary school tuition and expenses, including tutoring, computer equipment, software and services, room and board, uniforms, and extended-day program costs.

The current contribution phaseout range for joint filers (currently $150,000 -$160,000 of modified AGI) increases in 2002 to $190,000 - $220,000, which is double the amounts for single taxpayers. Corporations and other entities, including tax-exempts, will be able to contribute to education IRAs, regardless of their income. Contributions for a year will no longer have to be made by year-end, but can be made by the following April 15^th.

Also starting in 2002, HOPE and lifetime learning credits can be claimed in a year when excluded distributions are made from an education IRA for the same student, as long as credits aren’t claimed for amounts paid with tax-free distributions.

Qualified tuition programs. Qualified tuition programs will be expanded to include certain prepaid tuition programs established by educational institutions, including private institutions. Under the private plans, a person will be able to purchase tuition credits or certificates on behalf of a designated beneficiary, but, unlike state programs, won’t be able to make contributions to a savings account plan.

Also starting in 2002, distributions from qualified State tuition programs to pay higher education expenses will be tax-free. This exclusion also will apply to distributions from qualified private tuition plans starting in 2004. Qualified higher education expenses will include actual amounts charged for room and board for school-owned or –operated housing.

HOPE or lifetime learning credits will be able to be claimed for a student in the same year as a tax-free distribution is received from a qualified tuition plan as long as the tax-free distribution doesn’t pay expenses for which a credit is claimed.

Up to three transfers of credits or other amounts from one qualified tuition program to another for the benefit of the same beneficiary will be permitted.

Employer educational assistance plans. The exclusion for up to $5,250 of employer-provided educational assistance has been made permanent and extended to graduate education, effective for courses beginning after 2001.

Student loan interest deduction. For interest paid on qualified education loans after 2001, income phaseout ranges for eligibility for the student loan interest deduction will increase to $50,000 - $65,000 (from $40,000 - $55,000) for singles and to $100,000 - $130,000 (from $60,000 - $75,000) for joint filers. Also, the 60-month limit on interest deductibility will no longer apply.

Deduction for higher education expenses. For 2002 to 2005 only, certain taxpayers will be able to take an above-the-line deduction for qualified higher education expenses. In 2002 and 2003, the maximum deduction will be $3,000, available to taxpayers with AGI of up to $65,000 for singles and $130,000 for joint return filers. In 2004 and 2005, the maximum deduction will be $4,000 for taxpayers with incomes up to those levels, and $2,000 for singles with higher AGIs up to $80,000, or joint filers with AGIs up to $160,000. The deduction can’t be taken in the same year that a HOPE or lifetime learning credit is claimed for the same student. However, it can be claimed in the same year as an exclusion is available for distributions from an education savings account or a qualified tuition plan, or for interest on a redeemed education savings bond, as long as the deduction and exclusion aren’t claimed for the same expenses.

National Health and Armed Forces scholarships. Amounts awarded after 2001 under the National Health Service Corps or the Armed Services Scholarship Programs will be tax-free, without regard to any service obligation by the recipient, but not for amounts received by students for regular living expenses, including room and board.

If you would like more details about how any of these new rules might be used to your advantage, please contact us.

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Last modified: June 13, 2003