Powell Trachtman Logan Carrle & Lombardo

Design Professional's Practice Bulletin

Volume 6, Number 1 — July 2002
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This Bulletin addresses recent developments affecting Design Professionals as well as business concerns as important as the specific professional and technical issues they face.

Editors: Neil P. Clain and Richard J. Davies

Important Changes In The Tax Laws That May Affect You

By Thomas J. Bogar, J.D., LL.M.

On June 7, 2001, President Bush signed into law the “Economic Growth and Tax Relief Reconciliation Act of 2001” (the “Act”). It is the largest tax reduction legislation in the last twenty years. The Act contains changes to many aspects of the tax law. Some of the reductions are currently effective while the benefits from many others are delayed for years. Most of the tax benefits come from tax rate reductions, the incremental decrease in estate taxes, and an increase in child tax credits.

This article is intended to provide a relevant summary of the Act and how it may affect you and your business. Of significant importance is how the Act includes education-related tax benefits and provides increased retirement savings incentives for IRAs and 401ks. The Act also offers some tax relief to the individual alternative minimum tax (AMT).

Additional information on how the Act affects the estate tax can be found at our website www.powelltrachtman.com

INDIVIDUAL INCOME TAXES

Rate Reductions. The Act reduces the lowest tax rate to 10%, retroactive to January 1, 2001. Since this new rate is now 5% lower than the previous 15% floor, the net effect will be to reduce 2001 federal income taxes by at most $300 for individuals, $500 for heads of household, and $600 for joint filers. Taxpayers who timely filed their tax returns for 2000 should have received their advance refund before October 2001. If you filed later, or filed an extension, you can expect your refund later this fall.The Treasury Department will determine the amount of the refund based upon your last year’s returns.

Since June 30, 2001, each tax bracket has been reduced by 1%, and will incrementally decrease until eventually the brackets will be 10%, 15%, 25%, 28%, 33%, and 35% in 2006.

Marriage Penalty. Unfortunately, the Act does not provide relief to the marriage penalty until 2005 when it is phased in over the next four years by increasing the 15% bracket for joint filers. For those taking the standard deduction, the 15% bracket is increased in 2005 and gradually increases over the next five years.

Alternative Minimum Tax (AMT). The Act provides temporary relief by providing a $49,000 exemption for joint filers ($24,500 for married taxpayers filing separately and a $35,750 exemption for unmarried filers). The increases are temporary because they are effective 2001 through 2004. The Act also eliminates the prior adverse impact of the AMT upon the Child Tax Credit, the Earned Income Credit, and the Adoption Credit.

Child Credit. The Act retroactively increases the credit from $500 to $600 per child effective January 1, 2001.The credit then incrementally increases starting in 2005 so it will reach $1,000 in 2010.

Adoption Credit. The Act increases the credit $5,000 to $10,000 for special needs children and increases the income phase-out to $150,000, effective 2002.

Dependent Care Credit. Effective 2003, the dependent care credit limitations will increase to the maximum credit allowed ($3,000 for one dependent; $6,000 for two or more dependents) and the applicable percentage that is deductible will increase to 35%, with the phase out beginning at $15,000, instead of the $10,000 under prior law.

Employer-Provided Child Care. The Act creates a new credit worth as much as $150,000 for employers who provide employees with child care facilities or child care resource and referral services. This change becomes effective January 1, 2002.

Earned Income Credit. In 2002, the phase-out for joint filers of the earned income credit will incrementally increase until it is fully implemented in 2007. Non-taxable employee compensation is now excluded from earned income.

ESTATE, GIFT AND GENERATION SKIPPING TRANSFER TAXES

Unified Credit and Exemption. Beginning in 2002, the estate tax will be incrementally phased-out until it is eventually repealed in 2010. The phase-out and repeal similarly apply to generation skipping transfer taxes.The top tax brackets are scheduled to incrementally decrease from 50% in 2002 to 45% in 2009. Once the estate tax is phased out, there will no longer be a step-up in basis from inherited assets so that the gain in inherited assets sold by heirs will be measured from the date the assets were acquired by the decedent. However, the basis for certain property may be steppedup to its fair market value for transfers to spouses on the first $3,000,000 of property, and for transfers to all others on the first $1,300,000 of property.

The Act does not repeal the gift tax. In fact, the Act provides for a $1,000,000 lifetime gift tax exemption beginning in 2002, when the gift tax rates will gradually reduce until the top rate for transfers over $1,000,000 will be 35%.

EDUCATION PROVISIONS

Education Savings Accounts. In 2002, the contribution limit will be increased from $500 to $2,000. Also, the income phase-out range will increase to $190,000-$220,000 of modified adjusted gross income. Finally, the Act allows contributions by corporations or other entities and for tax-free distributions for grades K through 12 expenses, including tuition, computer technology or internet access.

Qualified Tuition Plans. Beginning in 2002, qualified distributions from state plans will be free from federal taxes. The Act also permits private prepaid tuition plans which meet certain conditions, and tax-free rollovers for the benefit of the same beneficiary.

Employer-Provided Education Assistance. Effective January 1, 2002, $5,250 of graduate education paid by an employer is excluded from the employee’s income. This provision is now made permanent under the Act because it was set to expire December 31, 2001.

Student Loan Interest Deduction. Beginning 2002, the 60-month limit will be repealed and the phase-out for the deduction will be increased to $50,000-$60,000 of modified adjusted gross income for single filers and $100,000-$130,000 for joint filers.

Qualified Higher Education Deduction. From 2002 to 2005, an above-the-line deduction for qualified tuition and related expenses will be allowed for taxpayers with adjusted gross income less than $130,000 (or $65,000 for singles). The maximum Important Changes In The Tax Laws… continued from page 1 deduction allowed is $3,000 in 2002 and 2003, and $4,000 thereafter.

RETIREMENT SAVINGS AND PENSION REFORM

Individual and Employee Contribution Limits. Beginning in 2002, IRA and Roth IRA contributions will increase from $2,000 to $3,000 per year, then gradually increase to $5,000 over the next seven years, and increase in $500 per year increments thereafter. Similarly, 401(k), 403(b) and simplified employee pension plan (“SEP”) contributions will increase from $10,500 to $11,000 per year over the next five years until they reach $15,000 in 2006, and increase in $500 per year increments thereafter. The dollar limit on annual elective deferrals to a SIMPLE plan is increased from $6,500 to $7,000 over the next four years until it reaches $10,000 in 2005.

The annual compensation limit that must be taken into account for determining contributions and benefits under a qualified plan is increased from $170,000 to $200,000, and will be indexed for inflation in $5,000 increments thereafter.Annual additions to a defined contribution plan have been increased from $35,000 to $40,000, and will be indexed in $1,000 increments thereafter. The limits on annual benefits received from a defined benefit plan have been increased from $140,000 to $160,000 and will be indexed in $5,000 increments thereafter.

Finally, the special rules limiting plan loans to 5 corporation shareholders, partners and sole proprietors have been eliminated, thus benefiting owners of many closely-held businesses.

Powell, Trachtman, Logan, Carrle, Bowman and Lombardo, P.C., believes it is essential that you be kept apprised of current legal developments that may affect you and your business.We welcome appointments with our tax and estate planning attorneys to discuss how the changes could affect your tax planning. Future articles will focus more directly on how the Act specifically effects estate planning, and on what education benefits are available in the Act.

This bulletin is intended for general information purposes only and does not constitute legal advice. The reader should consult with legal counsel to determine how laws, suggestions and illustrations apply to specific situations.