How Will the Tax Cut Benefit Me?

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By Roy Lewis
June 1, 2001

Welcome to the Economic Growth and Tax Relief Reconciliation Act of 2001, a $1.35 trillion tax-cut plan that will make many changes to the existing tax code. Some of the changes will take effect retroactively to Jan. 1, 2001, but most of the changes will hit in 2002 or later, and will be phased in over a number of years. Let's take a few minutes to review some of the tax changes in your future.

Rate reductions
The backbone of the legislation is an across-the-board cut in income tax rates. The legislation lowers the tax rate on the first $12,000 in taxable income for joint filers ($6,000 for single filers and $10,000 for Head of Household filers) to 10%, down from a rate of 15%. This rate cut would be made retroactive to the beginning of 2001. You'll soon receive a check from Uncle Sammy in lieu of getting the benefit of the rate cut on 2001 tax returns. You can expect your check ($300 for singles, $500 for Heads of Households, and $600 for married folks) before Oct. 1, 2001 if you filed your 2000 tax return by April 15. Those of you who filed extensions may have to wait a little longer.

Other tax rates, except for the 15% bracket, would gradually be lowered by three percentage points in three stages. The first cut will take effect July 1, 2001, the second in 2004, and the third in 2006. This means that in 2006, when the changes are fully implemented, the 39.6% rate will drop to 35%, the 36% rate will drop to 33%, the 31% rate will drop to 28%, and the 28% rate will drop to 25%.

Marriage penalty relief
The good news is that the marriage penalty issues were addressed. The not-so-good news is that the impact won't be felt until 2005, when the provisions begin to phase in. And it'll take five years of phasing in before the full relief will be fully realized. The relief comes in two forms. First, the standard deduction for married couples will be twice that of single folks. Second, the 15% bracket will be enlarged for couples so that more income gets taxed at the 15% rate instead of the next higher tax bracket.

Dependent care credit
The dependent care credit will be expanded effective in 2002. The amount of expenses eligible for the credit will be increased to $3,000 (up from $2,400) for one qualifying dependent, and to $6,000 for two or more qualifying dependents (up from $4,800). The maximum credit will also be increased from 30% to 35% of qualifying expenses.

Child tax credit
The child tax credit, which is now worth $500 per qualifying child, will eventually double to $1,000. The credit will increase to $600 in 2001 and will gradually rise to $1,000 by 2010.

Retirement savings
There were a number of changes to retirement plan contributions. Those changes include:

  • Higher contribution limits for 401(k), 403(b), and 457 plans: The maximum contribution in 2002 will amount to $11,000. Then that amount will rise until it reaches $15,000 in 2006. After that, the annual limit may rise with inflation, but only in increments of $500 per year.

  • "Catch-up" contributions for older workers: If you're age 50 or older, you'll generally be able to set aside even more in a 401(k), 403(b), or 457 plan. In 2002 you'll be able to contribute an extra $1,000. And that extra amount will phase in to $5,000 per year in years 2006 and later.

  • Higher contribution limits for SIMPLE plans: Effective in 2002, the maximum contribution to a SIMPLE plan will increase to $7,000 annually. And the maximum will continue to increase until it reaches a maximum of $10,000 in 2005. Workers age 50 or older will also be able to make additional catch-up contributions to their SIMPLE plans -- $500 in 2002 going up to an additional contribution of $2,500 in 2006 and later.

  • Higher IRA limits: You know that the maximum contribution to a traditional or Roth IRA is $2,000, but did you know that this maximum contribution amount hasn't been increased in 20 years? Well, it finally has. In 2002 the maximum contribution will increase to $3,000, and that amount will gradually increase to $5,000 in 2008. And catch-up provisions are also alive and well for older employees when it comes to IRA contributions. For workers 50 or older, an extra contribution of $500 is available in 2002, 2003, 2004, and 2005. In 2006 an extra $1,000 catch-up contribution will be allowed for older workers.

  • Retirement savings credits: If your income is low enough, and you're willing to put some money into a retirement savings plan at work or into an IRA account, Uncle Sammy will give you back some money in the form of a tax credit as an incentive to help you save. It's a bit complicated, and won't take effect until 2002. But basically, if your adjusted gross income is $50,000 or less ($25,000 or less if you're single), you'll qualify for the credit. The lower your income, the higher your credit.

Education tax breaks
There were also a number of education tax breaks, including:

  • Prepaid tuition plans: These plans will now be even more valuable. State-sponsored prepaid tuition plans will become completely tax-free in 2002. The same tax-free provisions will be extended to prepaid tuition plans for private colleges and universities beginning in 2004.

  • Employer-provided educational assistance: The law allows for a $5,250 tax break for graduate studies beginning in 2002. Currently only undergraduate courses qualify for this tax-free benefit.

  • Student loan deduction: This deduction has also become more valuable and also more available to taxpayers. First, the 60-month loan limit will be eliminated effective in 2002. The income eligibility limits will also be raised.

  • College tax deductions: This is a new deduction for college expenses that could be claimed in lieu of the Hope Credit or Lifetime Learning Credit. Because of the higher income limits on this deduction, it'll be more helpful for higher-income taxpayers who can't make use of the Lifetime or Hope credits. In 2002, taxpayers with adjusted gross incomes up to $65,000 ($130,000 for joint filers) will be entitled to a maximum deduction of $3,000 per year. And these deductions will rise in future years, but will lapse after 2005.

Estate tax repeal
The legislation will abolish the estate tax in 2010. In the meantime, the estate tax exemption (currently at $675,000) will gradually increase to $3.5 million in 2009. Additionally, the top estate tax rate will drop from 55% to 50%, and will gradually decline to 45%.

Legislative magic
Here's a kicker: Virtually all of the tax cuts in this legislation are scheduled to expire after 2010. And some provisions will expire much sooner than 2010. For example, provisions increasing the exemption from the alternative minimum tax for certain tax credits will extend only until 2004. And who knows what might happen to the tax law between now and 2010. So many of these provision might never take full effect; they may be revised or eliminated before they fully phase in.

More information
We've only hit the highlights here. There are other provisions that we haven't even touched on. If you would like to read more about the new laws, check out the Summary of Provisions for the tax act (H.R. 1836) at the Joint Committee on Taxation home page. You'll need an Acrobat reader to access the Joint Committee summary. If you don't have Acrobat reader, you can check out the summary provisions at Gary Klotts Tax Planet. And, of course, you can rest assured that we'll be discussing many of these provisions in greater detail in the weeks to come.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

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