Making Sense of the New Tax Legislation

EXECUTIVE SUMMARY * PRESIDENT BUSH SIGNED THE ECONOMIC GROWTH AND Tax Relief Reconciliation Act of 2001 into law June 7. The $1.35 trillion tax relief package affects almost every taxpayer in a variety of ways. CPAs may, need to reconsider some of the tax planning assumptions that have guided them over the last few years. * THE CENTERPIECE OF THE NEW LAW IS A CONSOLIDATION and reduction of the marginal tax rates for individuals. Most taxpayers will come out ahead as a result of the rate cuts, which include a new 10% tax bracket and advance refund checks--$300 for single taxpayers, $600 for married filing jointly and $500 for head of household--for most Americans. * LOWER TAX RATES MAY MAKE CLIENTS LESS INCLINED to jump through hoops to get the 20% rate on long-term capital gains. The lower rates also will make tax-deferred saving for retirement less of a priority, but they should make Roth IRAs more attractive. * THE 2001 ACT GRADUALLY INCREASES THE ESTATE TAX exemption to $3.5 million and then repeals the estate tax for one year--2010. The 10-year phase-in and the possibility the estate tax will return in 2011 will make careful planning essential. The estate tax repeal also means the step-up in basis at death is eliminated, subject to some modified-carryover-basis rules and exemptions. * CONGRESS INCREASED THE CONTRIBUTION LIMITS for traditional and Roth IRAs to $5,000 by 2008. Taxpayers age 50 and older will be permitted to make catch-up contributions to IRAs, 401(k) plans and other salary-reduction arrangements. Contributions to 401(k) plans also will be higher, increasing to $15,000 by 2006. At first, the Economic Growth and Tax Relief Reconciliation Act of 2001, the legislation Congress passed on May 26 and the President signed into law on June 7, appeared deceptively simple. The national press focused on the bill's hallmark across-the-board tax cut and advance refund, and taxpayers initially assumed most of the tax benefits would just happen on a fairly predictable schedule. In fact, the 10-year, $1.35 trillion tax relief package affects nearly all taxpayers in more ways than one. And experts are quickly recognizing its complexity. While the 2001 act introduces many new opportunities, it comes with pitfalls and challenges neither taxpayers nor tax practitioners can afford to overlook. This broad tax package offers plenty of planning alternatives, which will challenge CPAs to reconsider the tax-planning assumptions that have guided them in the last few years. The bottom line is that practitioners should get ready to crunch the numbers--time-based, phase-in projections and recommendations will drive tax planning now more than ever--even without the complication of the additional tax legislation that is sure to follow. INCOME TAX RATE CHANGES The centerpiece of the law is a $958 billion consolidation and reduction of the marginal tax rates for individuals, marking the first time since 1986 that ordinary income tax rates will drop. Most taxpayers come out ahead under these rate cuts, which start with a new 10% tax bracket carved out of the lower portion of the existing 15% bracket. For 2001 this will result in most taxpayers receiving advance refund checks. Congress also cut all other individual income tax rates, except the 15% bracket, for 2001 effectively by 0.5% across the board. Those cuts, however, will not result in advance refunds. The retroactive rate cuts for 2001--from the across-the-board benefit of the new 10% rate to the reduced 27.5%, 30.5%, 35.5% and 39.1% effective tax rates for 2001--amount to small change for some taxpayers compared to the benefits they will gain from rate cuts to come over the next five years. Through 2007, the new 10% bracket will apply to all income up to $12,000 on joint returns, $10,000 on head of household returns and $6,000 on the returns of single filers. After 2007, these amounts will be adjusted annually for inflation--as will the amounts for the other rate brackets. …