Exemptions, Deductions, and Other Tax Law Changes

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By Roy Lewis
July 13, 2001

There were many changes introduced by the Economic Growth and Tax Relief Reconciliation Act of 2001. We've covered many of them over the past weeks. Today, we'll take a look at changes that will affect the marriage penalty, the alternative minimum tax, the earned income credit, and high-income taxpayers. 

Marriage penalty relief
Because of quirks in the tax law dealing with tax rates, exemptions, standard deductions, and other issues, a married couple will USUALLY pay more in taxes than two single people with the same income. This is called the "marriage penalty." The new law will expand the 15% bracket for married folks to twice the size of that for singles. Additionally, the standard deduction for marrieds will be increased to twice the amount of that for single filers. That's the good news.

Now watch this: The bracket changes will phase in over four years beginning in 2005. The changes for the standard deduction will phase in over a five-year period beginning in 2005. This is really nothing more than statutory relief, and you'll get it simply based upon the numbers. The relief is modest in size and, while not saving you from the marriage penalty, will provide at least a little relief from it.   

Personal exemptions
Under the old rules, if you're a high-income taxpayer -- adjusted gross income (AGI) between about $200,000 and $322,000 for marrieds and between about $133,000 and $255,000 for singles -- your personal exemptions are phased out or eliminated. In effect, you pay additional taxes because you lost the benefit of your personal exemption deduction(s). The new law will gradually eliminate the loss of personal exemptions for high-income individuals. In other words, when the law is completely implemented, every taxpayer will be allowed the full tax benefit of their personal exemptions, regardless of the size of their income.

The phase-out begins in 2006 and continues through 2009. Thus, in 2010, you'll be entitled to your full personal exemption amount regardless of the amount of your adjusted gross income. So it'll take a few years before you receive the full benefit of this change.

Itemized deductions
If your AGI  is about $133,000 (for both married and single folks), you're required under the current rules to reduce your standard deduction by as much as 80%. In effect, you're paying additional taxes because you lost the benefit of all of your itemized deductions. The new law will gradually eliminate the overall limit on itemized deductions for high-income taxpayers. But this will take a while to implement also. The phase-out begins in 2006 and continues through 2009. Thus, in 2010, you'll be entitled to the full amount of your itemized deductions regardless of the amount of your AGI. 

Earned income credit
Introduced in 1975, the EIC was meant to provide tax relief to low-income taxpayers. Unfortunately, it's so darn confusing that many of the eligible folks don't take advantage of the credit. In the new law, new definitions of "earned income" and "child" will allow for an expansion of the credit to even more folks. Additionally, some new provisions will simplify the calculation of the EIC. (Did I say, "simplify"? When a law requires a number of paragraphs to define a "child," "simplify" is relative.) Nevertheless, the new rules go into effect in 2002. If you or anybody that you know might qualify for this credit, you'll do well to pay attention to these changes.

Alternative minimum tax
This is a tax assessed against taxpayers with a number of tax "preferences" such as excess depreciation, personal exemptions, state income tax deductions, medical expenses, miscellaneous itemized deductions, stock options, etc. Basically, you compute your "normal" tax, then compute your "minimum" tax, and your "alternative" is to pay the greater of the two amounts. (Not much of an alternative, eh?) The new law increases the AMT exemption amount (the amount of AMT-taxable income you can have before you begin to pay AMT) and the income phase-out amount (the amount of total income that you can realize that will reduce your AMT exemption).

This is effective for tax years 2001 to 2004. In 2005, this portion of the law is repealed, and the AMT exemption and income phase-out amounts will revert back to pre-2001 levels. So this relief is not only slight, but also fleeting. Like the daily tax double! Regardless, if you have AMT problems, this provision might offer you some slight relief. The AMT is still an intrusive tax for many individuals, and still requires planning above and beyond normal tax issues. It's often smart to consult a tax pro about it.

So there you have them -- the "other" issues in the Tax Accountant's Right To Work Act of 2001... er... The Economic Growth and Tax Relief Reconciliation Act of 2001. There are even more obscure issues buried in the new tax act that might just have some impact on one or two of you out there. But they are simply too numerous to mention here or anywhere else. So it might not be a bad idea to review the entire outline of the new act. If you have Acrobat Reader (free from www.adobe.com), you can visit the House Ways and Means Committee website and read the entire text of the new law.

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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