Dear Clients and Friends:

The tax relief act of 2001, now law, provides great tax news to you in a very complex package phased over many years. Filers of 2000 tax returns with at least $6,000 taxable income if single, $10,000 if head of household and $12,000 if married will receive an advance on the 2001 tax rate reduction on those levels from 15% to 10%. Those of you who’ve already filed will receive notices in early July regarding this credit (to $300 for singles, $500 for heads of households and $600 for married filers) and checks by October. This is another incentive for you to quit procrastinating if you haven’t yet filed. The cash credit is provided this year as an economic stimulus. Adjustment is calculated on your 2001 return, so if you don’t have enough taxable income in 2000 to receive full payment, you will get credit on your 2001 return for the difference, if greater. No repayment will be due if your 2001 taxable income is less.

After June 30, 2001, each rate bracket beyond the 15% bracket will be reduced by 1%: 28% goes to 27%; 31% to 30%; 36% to 35%; and 39.6% to 38.6%, until 2003. That gives you effectively a ½% rate reduction on your taxable income above the 15% level for 2001, and 1% reduction for 2002. Another 1% reduction in those rates takes effect in 2003, followed by another for 2004 through 2005, with the third scheduled 1% rate reduction for 2006 and later years. Bracket ranges will continue to be indexed for inflation as rates are decreasing. The IRS website already has new withholding tables for employer adoption as of July 1. Should you need to protect your withholding level currently for underpayment penalty avoidance, you may wish to file new W-4s with your employers requesting supplemental withholding by amount.

1. Lessening of the personal exemption phase-out and limitations on itemized deductions from 2005 to elimination of them after 2009.

2. Temporary increase in the alternative minimum tax exemption amount (though repeal did not survive the political process, unfortunately) by $4,000 for married individuals filing jointly and $2,000 for all others beginning 2001 through 2004.

3. Marriage penalty relief begins 2005 (indicative of the largely back-loaded time frame for this estimated 1.35 trillion dollar tax cut). Increases are scheduled in both the standard deductions and 15% tax rate range. The standard deduction will rise for joint filers to 174% of single’s standard deduction in 2005; 180% in 2006; 187% in 2007; 190% in 2008 and 200% in 2009 and later. Their 15% rate range will be 180% of single’s in 2005; 187% in 2006; 193% in 2007 and 200% in 2008 and later. Since most married couples in the new 25% rate range itemize, the standard deduction increase will not affect them. Those in the 15% rate already will not be affected by the expansion of that rate range.

4. The child tax credit of $500 in 2000 is gradually increased to $1,000 by 2010 as follows: $600 in 2001-2004; $700 in 2005-2008; $800 in 2009 and $1,000 for 2010 and later. However, existing adjusted gross income limits for the credit of $110,000 for joint filers and $55,000 for single filers remains unchanged throughout.

5. Other child-related credits to be expanded:

a. Adoption credit increases from $6,000 for special needs children to $10,000 and from $5,000 to $10,000 for other children, effective 2002. Income phase-out ranges begin at $150,000 then (double the current $75,000).

b. Dependent care credit rate maximum rises in 2002 from 30 to 35% on expenses to $3,000 (vs. $2,400) for one qualifying individual and $6,000 (vs. $4,800) for more than one, and the beginning point of phase-out income increases to $15,000.

c. Employers will receive tax credits of 25% of qualified expenses for employee child care and 10% of qualified expenses for child care resource and referral services to a maximum credit of $150,000 per year beginning 2002.

6. College tuition deductions above-the-line (available for non-itemizers) to a maximum of $3,000 in 2002-2003 are introduced in 2002 if HOPE or lifetime learning credits are not claimed for the same student dependent for single taxpayers with adjusted gross income below $65,000 ($130,000 if married). The deduction rises to $4,000 for singles with incomes below $65,000 ($130,000 for marrieds filing jointly) while singles with incomes to $80,000 (and marrieds to $160,000) will be permitted maximum deduction of $2,000 in 2004 and 2005. This deduction option is scheduled to end in 2005.

7. Education IRAs, now called education savings accounts, are expanded in 2002 to broaden eligible contributors to include joint filers with incomes below or in the phase-out range of $190,000-$220,000, which is double the single range, and corporations, tax-exempt organizations and other entities. Contribution limits rise to $2,000 from $500 per year in 2002, and can be made to April 15 of the following year. Contributions for special needs individuals can be made after beneficiaries turn 18. Distributions used to pay qualified education expenses, which now include tutoring, computer equipment, room and board and extended day program costs for kindergarten through 12^th grades (public and private) as well as higher education costs, are tax-free. Finally, HOPE or lifetime learning tax credits can be taken in the same year as education IRA distributions, as long as the distributions pay for other costs than claimed for the credits, and penalty-free contributions can be made to education savings accounts and qualified state tuition programs in the same year.

IRA contribution limits increase from $2,000 to $3,000 annually in 2002-2004; $4,000 for 2005-2007 and $5,000 for 2008 and later with annual adjustments for inflation after 2008. Taxpayers age 50 and older can make additional contributions if eligible of $500 per year from 2002-2005 and $1,000 per year afterwards to regular or ROTH IRAs.

401(k), 403(b) and salary-reduction SEP contributions rise from $10,500 this year to $11,000 in 2002 with additional $1,000 per year increases to the $15,000 level in 2006 and later. Lower income workers over 18 and not a student dependent of another will be entitled to a new 50% maximum tax credit on the first $2,000 of qualified retirement contributions if their joint income is less than $30,000 (phased-out to $50,000); or $22,500 for heads of households (phased-out to $37,500) and $15,000 for others (phased-out to $25,000). This credit will commence 2002 and expire after 2006. SIMPLE plan contribution limits now $6,500 per year in 2001 rise to $7,000 in 2002 and another $1,000 per year to $10,000 in 2005, with maximum pay for employer match rising to $200,000. Additional "catch-up" contributions can be made by participants over 50 if income limits are achieved for 401(k), 403(b), SEP or 457 plans of $1,000 for 2002; $2,000 for 2003; $3,000 for 2004; $4,000 for 2005; and $5,000 for 2006 and later years. The amounts for SIMPLE plans are $500 for 2002; $1,000 for 2003; $1,500 for 2004; $2,000 for 2005 and $2,500 for 2006 and later. Amounts are adjusted for inflation after 2006. Profit-sharing plan contributions by employers after 2001 are increased to a maximum of 25% of employee contributions (vs. 15%). Money purchase pension plans are subject to the same limitation after 2001.

Employers with fewer than 100 employees earning $5,000 or more in the prior year will be able to claim a tax credit of 50% to $500 maximum for the administrative and retirement education expenses related to adoption of a new 401(k), SEP or SIMPLE plan, beginning after 2001. SIMPLE and SEP costs are so minimal, I wouldn’t recommend delay for the credit.

Beginning 2002, rollover options for eligible distributions from various qualified plans are being expanded to include other qualified plans which allow for such rollovers and their accounting. Your plan administrators will be advising you when the occasion arises. That’s also a good time to consult with us.

Estates of decedents in 2010 will be free of taxes under the new law. Between now and then phase-out, though slow, is accelerated. After 2010, the whole issue needs to be addressed by Congress again, since the current law reinstates the current tax with only $1,000,000 exemption:

The generation-skipping tax will be equal to the highest estate tax rate during the ten-year period to 2009.

If not addressed later, the law now implements a "modified carryover basis" rule upon estate tax repeal in 2010 to replace the stepped up basis for inherited assets now in effect. However, $3,000,000 of basis can be added to inherited assets by a surviving spouse and $1,300,000 basis can be added to most other assets transferred to heirs except for assets acquired by gift from a non-spouse within 3 years of the date of death, property that constitutes a right to receive income in respect of the decedent and stock in foreign investments and personal holding companies.

Conclusion

This is definitely not tax simplification. However, I believe it is good news for you. Planning continues to be important if you are to maximize your tax savings. Later this year we may see additional legislation regarding such issues as capital gains reduction, bankruptcy reform, alternative minimum taxes, small business taxes, as well as any corrections needed in this very comprehensive tax law.

Sincerely,
Jim Fielder, Jr.