On June 7, 2001, President Bush signed the most sweeping tax cut legislation in 20 years. This mammoth tax bill contains 85 major provisions, 441 changes to the Internal Revenue Code, and almost 300 pages of text. The Act contains a laundry list of effective dates, ranging from current to 10 years down the road. Perhaps, the strangest aspect of this legislation is the sunset provision that was included to satisfy technical Senate budget requirements, none of the changes made by the 2001 Act will apply to years beginning after 2010 unless Congress acts to extend the provisions of the Act.

This alert is intended to be a brief summary of the provisions that we believe affect the largest number of our clients. Accordingly, we do not discuss some of the more technical provisions of the Act. Also, we have tried to explain the provisions covered in as few words as possible. If you are interested in a tax change that is not addressed here, or you want a more in-depth explanation of the Act, please call our office. Caution! Call us before adopting any tax planning recommendation.

HIGHLIGHTS OF INCOME TAX RATE CUTS

Congress Cuts Tax Rates. This across-the-board cut in regular tax rates is the first cut in rates since 1986, and it represents over 60% of the cost of the entire $1.35 trillion tax package. The new law (when fully phased in) will contain the following six tax brackets (up from 5 brackets under current law): 10%, 15%, 25%, 28%, 33%, and 35%. Caution! This rate cut is not immediate. Indeed, it will not be fully phased in until 2006. Planning Alert! The Act does not change the maximum tax rates for long-term capital gains.

10% Bracket Retroactive To January 1, 2001. To provide an economic stimulus, Congress made the new 10% tax bracket retroactive to January 1, 2001. The 10% rate will apply to the first $6,000 of taxable income for single filers, the first $10,000 for heads of households, and the first $12,000 for joint filers. The 15% rate will continue to apply to amounts in the "old" 15% rate bracket in excess of the amounts subject to the new 10% rate. The new 10% rate does not apply to trusts or estates.

Tax Rebate Checks This Year. This retroactive rate cut means that for 2001, your taxes will be reduced by up to $300 if you file as single, up to $500 if you file as head of household, and up to $600 if you're married filing a joint return. If you filed a 2000 return, you should receive a notice from the IRS by this July indicating the amount of your rebate and when you can expect to receive it. The amount of the rebate is computed based on your 2000 tax return (not your 2001 return), even though it’s actually a refund of 2001 taxes. If you filed your 2000 return by April 16, 2001, you’ll be first in line to get your check and you should receive it by October 1, 2001. If you filed your 2000 return after April 16, 2001, you probably won’t receive your check until later in 2001. Planning Alert! The rebate is available only to individuals, and will not go to estates, trusts, nonresident aliens, or dependents. Also it will have to be reconciled on your 2001 return and some of it may have to be returned.

Child Tax Credit Increased. For 2000, you were allowed a $500 tax credit for each child under age 17 and the credit was reduced if your "modified adjusted gross income" on a joint return exceeded $110,000 ($75,000 if single). Generally, if your total child credits exceeded your entire income tax obligation, the excess was not refundable to you. However, if you had three or more children, the excess was refundable to you up to the amount your Social Security taxes exceeded your earned income tax credit. Effective after 2000, the new law increases the child credit as follows: 2001-2004 ($600 per child); 2005-2008 ($700 per child); 2009 ($800 per child); 2010 and thereafter ($1,000 per child). Furthermore, beginning in 2001, if your total child credits exceed your entire income tax obligation, you may be entitled to a refund of all or a portion of the excess -- regardless of the number of children you have.

Expansion Of Adoption Tax Credit. After 2001, the adoption credit (1) is increased to a maximum of $10,000 per child (including special needs children), (2) is made permanent (previously, it was a temporary credit except for special needs children), and (3) is not reduced by the alternative minimum tax. Under existing law, the credit is phased out if your modified adjusted gross income is between $75,000 and $115,000. Effective after 2001, the adoption credit is phased-out as your modified adjusted gross income increases from $150,000 to $190,000.

Expansion Of Dependent Care Credit. Effective after 2002, the Act increases the top dependent care credit rate from 30% to 35%, increases the maximum amount of eligible expenses from $2,400 to $3,000 for one child (from $4,800 to $6,000 if you have more than one qualifying child), and increases the beginning income phase-out level from $10,000 to $15,000 (the credit percentage is reduced to 20% once your adjusted gross income exceeds $43,000).

MARRIAGE PENALTY RELIEF

If you are married and file a joint return with your spouse, you may be paying more income tax than the total you and your spouse would have paid if you were each single, the so-called "marriage penalty". The Act reduces, but does not eliminate, the tax penalty for marriage. Also, most of these "relief" provisions do not begin until 2005.

NEW TAX INCENTIVES FOR EDUCATION EXPENSES

In 1997, Congress created a host of new tax breaks for education expenses. The Act expands and liberalizes the benefits of these tax breaks. Most of these changes are effective after 2001.

Annual Education IRA Contribution Limit Increased From $500 to $2000. Currently, the earnings on funds placed in an education IRA escape taxation if the funds are used for qualified education. You can make nondeductible contributions to education IRAs up to $500 annually for each beneficiary. The Act increases the annual limit for contributions to education IRAs from $500 to $2,000 after 2001. This limit applies to the aggregate contributions that may be made by all contributors to one (or more) education IRAs established on behalf of any particular beneficiary.

Phase-Out Limit Increased For Education IRAs. For 2001, your ability to contribute to an education IRA is phased out ratably as your modified adjusted gross income increases from $150,000 to $160,000 on a joint return (from $95,000 to $110,000 on a single return). After 2001, the income phase-out range for married taxpayers filing a joint return is from $190,000 to $220,000. Planning Alert! The income phase-out range for single taxpayers is not changed by the new law.

Qualified State Tuition Programs. Distributions from a "qualified state tuition program" will be tax-free if used to pay qualified education expenses after 2001.

Student Loan Interest Deduction Rules Relaxed. For 2001, you can deduct (whether or not you itemize deductions) up to $2,500 of interest on qualified student loans. You can only deduct interest paid during the first 60 months the interest payments are required and the deduction is phased out ratably as your modified adjusted gross income increases from $60,000 to $75,000 on a joint return (from $40,000 to $55,000 on a single return). The current rules do not allow you to deduct interest you voluntarily pay while the student loan is in a deferral or forbearance status. After 2001, the 60-month limitation is repealed and the interest can be deducted even if voluntarily paid while the loan is in deferral or forbearance status. Furthermore, the income phase-out ranges are increased to $100,000 - $130,000 on a joint return, and to $50,000 - $65,000 on a single return.

New Education Expense Deduction. The Act, after 2001, allows you to deduct (whether or not you itemize) up to $3,000 (for 2002 and 2003 increased to $4,000 in 2004 and 2005) of qualified education expenses in lieu of taking the HOPE or lifetime learning credits. You are not allowed this deduction if your adjusted gross income exceeds $130,000 on a joint return ($65,000 if single). However, for 2004 and 2005 if your adjusted gross income is between $130,000 and $160 000 on a joint return (between $65,000 and 80,000 on a single return), you are allowed a reduced deduction of $2,000. This education expense deduction is allowed only through 2005.

HIGHLIGHTS OF RETIREMENT SAVINGS AND PENSION REFORM

The Act includes pro-taxpayer changes to regular IRAs, Roth IRAs, SIMPLE IRAs, 403(b) tax deferred annuities, section 457 plans and employer-sponsored retirement plans. The retirement plan changes in this new legislation are far too lengthy to discuss completely in this letter. We have included below the provisions we believe have the broadest impact.

Increased Contributions To Traditional And Roth IRAs. Currently, if you qualify, you may make a contribution to a traditional deductible IRA or to a nondeductible Roth IRA of up to $2,000 annually. After 2001, the maximum annual contribution to a traditional IRA or a Roth IRA increases as follows: 2002-2004 ($3,000); 2005-2007 ($4,000); 2008 and thereafter ($5,000). If you are age 50 by year end, your maximum contribution is even higher: 2002-2004 ($3,500); 2005 ($4,500); 2006-2007 ($5,000); 2008 and thereafter ($6,000).

Increased Elective Deferrals For 401(k) Plans, Etc. For 2001, the maximum amount of compensation you can elect to put into a 401(k) plan, 403(b) plan, or salary reduction SEP (SARSEP) plan is $10,500. The maximum amount for a SIMPLE plan for 2001 is $6,500. For 2002, the maximum (except for SIMPLE plans) will increase to $11,000, and will continue to increase $1,000 each year thereafter until it reaches $15,000 in 2006. The maximum amount you can put into a SIMPLE plan in 2002 will increase to $7,000, and will continue to increase $1,000 each year thereafter until it reaches $10,000 in 2005. If you reach age 50 by the end of the tax year, the maximum elective deferral amounts are even larger.

New Credit For Elective Contributions. The Act creates a new tax credit for low and middle-income taxpayers who make elective contributions to qualified retirement plans. After 2001, qualifying taxpayers will generally be entitled to a tax credit of up to 50% of their elective contributions (up to $2,000) to a section 401(k) plan, section 403(b) plan, section 457 plan, SIMPLE plan, SEP plan, traditional IRA or Roth IRA. The credit is also available for employees’ elective nondeductible contributions to qualified plans. The maximum credit is $1,000 (50% of $2,000).This 50% credit is phased out at certain income levels, and is phased out completely once adjusted gross income exceeds the following levels: joint return-$50,000; head of household-$37,500; all other filers-$25,000. Planning Alert! This is a temporary and non refundable tax credit which is scheduled to automatically terminate after 2006.

REPEAL OF ESTATE AND GENERATION-SKIPPING TAXES (GIFT TAX REMAINS)

The Act contains a laundry list of significant changes (generally pro taxpayer) to the existing estate, gift, and generation-skipping tax rules. The following is a summary of selected estate, gift and generation-skipping provisions of the Act:

Tax Basis of Property Acquired From An Estate. After 2010 the basis of assets received from a decedent will not be automatically stepped up to the value as of the date of death, as they are now. Up to $1.3 million can be stepped up for non-spouses, and $3 million for spouses, under a set of very complicated rules. This will require keeping updated basis records for each asset owned, and put a significant burden on estate administrators.

Gift Tax. The gift tax is retained even after 2009. The top gift tax rates will be the same as the maximum estate tax rates listed above from 2002 through 2009. After 2009, the top gift tax rate will drop to 35% (the maximum individual income tax rate). The maximum exclusion from gift taxes under the Act will be $1,000,000 after 2001. In other words, the amount exempt from gift tax is capped at $1,000,000 for 2002 and subsequent years even though the amount exempt from the estate tax continues to increase after 2003.