The Top 10 Essentials of the 2001 Tax Relief Reconciliation Act

AccountingWEB has compiled this top ten list of the 2001 Tax Relief Reconciliation Act for your convenience. You may also order a summary for your Web Site or Client Handouts from AccountingWEB.

Table of Contents:

  1. Tax Rebates
  2. Income Tax Rate Reductions
  3. Marriage Penalty
  4. Itemized Deductions and Personal Exemption Phase-Outs For High-Income Taxpayers
  5. Child Tax Credit
  6. IRA Contributions
  7. Contributions To Employer Sponsored Retirement Plans
  8. Tax Credit For Retirement Contributions
  9. Dependent and Child Care Credit
  10. Estate Tax


1. Tax Rebates

The rate of income tax on the first $6,000 earned by every single taxpayer, which is currently 15%, will drop to 10%, retroactive to January 1, 2001. This represents a $300 tax saving in 2001 for every single taxpayer who will pay tax on at least $6,000 in income. For head of household taxpayers, the 10% rate applies to the first $10,000 earned, and for married taxpayers filing jointly, the 10% rate applies to the first $12,000 earned.

Rather than waiting until next spring to let taxpayers see the difference this new rate makes in their tax bill, Congress has authorized the Treasury Department to cut rebate checks this summer, returning up to $300 to every single taxpayer, $500 to each head of household taxpayer, and $600 to married couples. Look for your check to appear by September. You have to have filed your 2000 tax return on time to receive a check.

Summary of provision:

The rate of income tax on the first $6,000 earned by every taxpayer filing with the single status or the married filing separately status, which had been 15 percent under prior law, is now 10 percent. This change represents a $300 annual difference in income tax owed by every single-status and married filing separately status taxpayer with taxable income of at least $6,000.

For taxpayers filing with the head of household status, the 10 percent rate applies to the first $10,000 earned. This change represents a $500 annual difference in tax for these taxpayers.

For taxpayers filing with the married filing jointly status, the 10 percent rate applies to the first $12,000 earned. This change represents a $600 annual difference in tax for these taxpayers.

The change is retroactive to January 1, 2001. To drive home the fact that a new tax law is in place, Congress has authorized the Treasury Department to implement this tax rate change in the form of a nationwide tax rebate. Taxpayers will receive a letter in July informing them of the impending tax rebate. The actual rebate will occur later in the summer.

Taxpayers with taxable income who filed timely 2000 tax returns will receive the rebate, even if their taxable income from 2001 does not qualify them for a rebate. Rebates sent to non-qualifying taxpayers will not have to be returned.


2. Income Tax Rate Reductions

Other tax rate reductions will phase in over the next five years. The current tax rates of 28%, 31%, 36%, and 39.6% will be reduced to 25%, 28%, 33%, and 35%.

Summary of provision:

New income tax rates in effect for years after 2000 are as follows:

10 percent tax rate - will apply to the new initial tax bracket for all taxpayers. This bracket is the first $6,000 of income for single and married-filing-separately taxpayers, the first $10,000 for head of household taxpayers, and the first $12,000 for married filing jointly taxpayers. The initial tax bracket amount will change for married filing jointly taxpayers from $12,000 to $14,000 in 2008.

15 percent tax bracket - the 15 percent tax bracket that existed prior to this law will remain in place, however the 10 percent rate will apply to the income designated as part of the initial tax bracket. The remaining income in this bracket will be taxed at 15 percent.

28 percent tax bracket - the former 28 percent tax bracket will be reduced to 25 percent at the following phase-in rates:

2001 - 27.5 percent
2002 - 27 percent
2003 - 27 percent
2004 - 26 percent
2005 - 26 percent
2006 - 25 percent

31 percent tax bracket - the former 31 percent tax bracket will be reduced to 28 percent at the following phase-in rates:

2001 - 30.5 percent
2002 - 30 percent
2003 - 30 percent
2004 - 29 percent
2005 - 29 percent
2006 - 28 percent

36 percent tax bracket - the former 36 percent tax bracket will be reduced to 33 percent at the following phase-in rates:

2001 - 35.5 percent
2002 - 35 percent
2003 - 35 percent
2004 - 34 percent
2005 - 34 percent
2006 - 33 percent

39.6 percent tax bracket - the former 39.6 percent tax bracket will be reduced to 35 percent at the following phase-in rates:

2001 - 39.1 percent
2002 - 38.6 percent
2003 - 38.6 percent
2004 - 37.6 percent
2005 - 37.6 percent
2006 - 35 percent


3. Marriage Penalty

The disparity in tax rates among single and married taxpayers will disappear over the next eight years. By 2009, two married taxpayers will pay the same tax as two single taxpayers earning the same amount of income. The phase-in of this change will begin in 2005.

Summary of provision:

Congress has voted to alleviate the disparity in tax rates among single and married taxpayers. To that end, the following changes will be made to the tax laws:

The marriage penalty in the standard deduction will be eliminated, thus doubling the amount of the single taxpayer standard deduction for married couples.

The 15 percent tax bracket will be extended for married filing jointly taxpayers so that it is double that of single taxpayers.

These changes are to be phased in according to the following schedule:

2005 - MFJ standard deduction will be 174 percent of single standard deduction; the 15% tax bracket for married taxpayers will be expanded to 180 percent of the single 15 percent tax bracket.

2006 - MFJ standard deduction will be 184 percent of single standard deduction; the 15% tax bracket for married taxpayers will be expanded to 187 percent of the single 15 percent tax bracket.

2007 - MFJ standard deduction will be 187 percent of single standard deduction; the 15% tax bracket for married taxpayers will be expanded to 193 percent of the single 15 percent tax bracket.

2008 - MFJ standard deduction will be 190 percent of single standard deduction; the 15% tax bracket for married taxpayers will be expanded to 200 percent of the single 15 percent tax bracket.

2009 and thereafter - MFJ standard deduction will be 200 percent of single standard deduction.


4. Itemized Deductions and Personal Exemption Phase-Outs For High-Income Taxpayers

The phase-out of itemized deductions and personal exemptions that is currently experienced by taxpayers in higher tax brackets will begin to disappear in 2006 and will disappear completely in 2010. Thus taxpayers in higher tax brackets will be entitled to take the full amount of itemized deductions and personal exemptions to which other taxpayers are entitled.

Summary of provision:

Currently, taxpayers in higher income brackets are not allowed to deduct the full amount of the personal exemptions and the itemized deductions allowed other taxpayers. This disparity will be removed so that all taxpayers have equal access to personal exemptions and itemized deductions, no matter their income level.

The limitation on itemized deductions for high-income taxpayers will be completely eliminated.

The limitation on personal exemptions for high-income taxpayers will be completely eliminated.

The limitations on itemized deductions and personal exemptions will be reduced according to the following schedule:

2006 - 1/3 of the limitation on itemized deductions and personal exemptions will be removed.

2007 - the same rate will apply as for 2006.

2008 - 1/2 of the remaining limitation (2/3 of the current limitation) on itemized deductions and personal exemptions will be removed.

2009 - the same rate will apply as for 2008.

2010 - the limitation on itemized deductions and personal exemptions will be completely removed.


5. Child Tax Credit

The Child Tax Credit, which is currently $500 for each dependent child under age 17, will gradually increase to $1,000. Look for the start of this change with your 2001 tax return, when the credit will be increased to $600. The credit will not reach its target of $1,000 until 2010.

Summary of provision:

The Child Tax Credit, current $500 per dependent child under age 17, will be increased to $1,000 per child. The increase will be phased in according to the following schedule:

2001 - $600 per qualifying child
2002 - $600 per qualifying child
2003 - $600 per qualifying child
2004 - $600 per qualifying child
2005 - $700 per qualifying child
2006 - $700 per qualifying child
2007 - $700 per qualifying child
2008 - $700 per qualifying child
2009 - $800 per qualifying child
2010 and thereafter - $1,000 per qualifying child


6. IRA Contributions

Participants in IRA (regular and Roth) accounts will see an increase in the amount they can contribute each year. Starting in 2002, the maximum contribution rises to $3,000. By 2008, the annual contribution will be $5,000.

Summary of provision:

Taxpayers will be entitled to contribute up to $5,000 to traditional and Roth IRA accounts. Also, beginning in 2002, taxpayers age 50 or older will be able to make additional contributions to IRA accounts.

Allowed annual contributions to IRA accounts will increase at the following rate:

2001 - $2,000
2002 - $3,000
2003 - $3,000
2004 - $3,000
2005 - $4,000
2006 - $4,000
2007 - $4000
2008 - $5,000

Contribution limits will be adjusted for inflation after 2008.

The catch-up provisions, as they are being called, for taxpayers age 50 and over, will work like this:

In years 2002-2005, these taxpayers may contribute an extra $1000 above the regular limits to an IRA account. In 2006 and thereafter, taxpayers over age 50 may contribute $1,000 over the regular limits to IRAs.


7. Contributions To Employer Sponsored Retirement Plans

Contributions to 401(k) and similar plans, now capped at $10,500 per year, will increase to $11,000 in 2002 and will gradually increase to $15,000 by 2006.

Summary of provision:

The annual contribution limit to 401(k) and similar plans, such as 403(b) and other salary reduction plans, will increase from the current $10,500 to $15,000.

The phase-in of the change in the annual contribution limit will occur as follows:

2001 - $10,500
2002 - $11,000
2003 - $12,000
2004 - $13,000
2005 - $14,000
2006 - $15,000

A catch-up provision for 401(k) and similar employer plans goes into effect in 2002, allowing taxpayers age 50 and over to make contributions to such plans above the normal limits.

The catch-up contributions will be phased-in as follows:

2001 - no catch-up allowed
2002 - $1,000
2003 - $2,000
2004 - $3,000
2005 - $4,000
2006 - $5,000

This amount will be adjusted annually for inflation after 2006.

The tax act provides for the creation of a Roth 401(k) plan and a Roth 403(b) plan, operating on the same principle as the Roth IRA, whereby contributions can be made to these plans without a current tax deferral, but with no tax owing on the earnings of the plan.


8. Tax Credit For Retirement Contributions

Single taxpayers with income of $25,000 and under will qualify for a tax credit if they contribute to a retirement plan. The credit is available to head of household filers with income up to $37,500, and to married taxpayers who file jointly if their income does not exceed $50,000. The credit will range from 10% to 50% of a contribution to a retirement plan - the lower the income the higher the credit.

Summary of provision:

Low-income taxpayers age 18 and over (not including dependents and full time students) will be encouraged to contribute to retirement accounts with the offer of a tax credit of up to 50 percent of the retirement contribution. The program, which is a kind of matching funds program, requires that taxpayers first make the contribution, then they will be reimbursed when they file their tax returns.

The 50 percent credit will apply to the following levels of adjusted gross income:

Joint return: $30,000 and under
Head of household return: $22,500 and under
All other returns: $15,000 and under

A 20 percent credit will apply to the following levels of adjusted gross income:

Joint return: over $30,000 up to $32,000
Head of household return: over $22,500 up to $24,375
All other returns: over $15,000 up to $16,250

A 10 percent credit will apply to the following levels of adjusted gross income:

Joint return: over $32,000 up to $50,000
Head of household return: over $24,375 up to $37,500
All other returns: over $16,250 up to $25,000


9. Dependent and Child Care Credit

The maximum dependent care credit, which is currently $2,400 for one child and $4,800 for two or more children, will increase to $3,000 and $6,000 respectively. The change is effective in 2003.

Summary of provision:

The credit for care of dependents and children while a taxpayer works or attends school is increased to a maximum of 35 percent of expenditures, with a new cap of $3,000 for one dependent and $6,000 for two or more children.

The change is effective beginning in 2003.

Employers will be allowed a credit equal to 25 percent of qualified expenses for employee child care and 10 percent of qualified expenses for child care resource and referral services, to a maximum $150,000 per year credit. This provision is effective beginning in 2002.


10. Estate Tax

The federal estate tax will be repealed in 2010, however the tax benefit of a stepped-up basis for assets in an estate is simultaneously repealed, so people who inherit stocks and other appreciated property will still be subject to tax.

These are the high profile elements of the tax law - the changes that most taxpayers seem to care the most about. As always, there are tons of changes under the surface that affect lesser-known areas of the tax code. There are 85 major changes to tax provisions as a result of this legislation; 441 sections of the Internal Revenue Code will be changed, and the tax bill itself is 291 pages.

The estimated effect of this legislation is a total reduction of $1.35 trillion in federal income over 10 years. It is assumed that the projected federal budget surplus will more than cover the reduction in tax revenue and most existing federal programs will not have to be cut to accommodate these changes.

Summary of provision:

The federal estate tax is repealed beginning (and ending) in the year 2010. Congress will have to vote to extend the repeal after 2010 or else the sunset provisions of the tax act will require that the estate tax be reinstated in 2011.

Meanwhile, the amount of an estate that is exempt from tax will rise to $3.5 million and the maximum rate of estate tax will drop to 45 percent during this period, at the following pace:

2002 - maximum rate 50 percent, exempt estate value $1,000,000

2003 - maximum rate 49 percent, exempt estate value $1,000,000

2004 - maximum rate 48 percent, exempt estate value $1,500,000

2005 - maximum rate 47 percent, exempt estate value $1,500,000

2006 - maximum rate 46 percent, exempt estate value $2,000,000

2007 - maximum rate 45 percent, exempt estate value $2,000,000

2008 - maximum rate 45 percent, exempt estate value $2,000,000

2009 - maximum rate 45 percent, exempt estate value $3,500,000

2010 - no estate tax

2011 - maximum rate 55 percent, exempt estate value $1,000,000

In addition to the above changes to the estate tax rules, when the estate tax is repealed in 2010, the current rule allowing assets to transfer to an estate at a stepped-up basis will also be repealed, meaning that assets will transfer to heirs at the basis of the decedent. Assets received as an inheritance and subsequently sold would be subject to capital gain tax based on the basis of the decedent.

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