Tax

" The hardest thing in the world to comprehend is the income tax." 

Albert Einstein

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was signed into law by President Bush on June 7, 2001. It is a very complex tax bill which modestly lowers income tax rates, significantly reduces and evidentially eliminates the estate tax, increases the benefits of saving for a college education and substantially increases the benefits of retirement funding.

Golden Gate Advisors, Inc. shall summarize the major provisions and resulting tax strategies here: (Please note that some of the rates and income amounts could change as they are currently under consideration in Congress. We will keep you posted as proposals become law.)

Marginal Income Tax Rate Reduction: New 10% Income Tax Rate: A new tax bracket of 10% is added for the first $6,000 of taxable income for single individuals, the first $10,000 for heads of households and the first $12,000 on joint returns. In 2008, the income amounts are $7,000, $10,000 and $14,000 respectfully. The amounts are adjusted for inflation after 2008.  The new rates applies to individual taxpayers but not to trusts and estates. Trust and estates are reduced to 15%, 25%, 28%, 33% and 35% by 2006 but on more restrictive income levels.

    Reduction in other tax brackets: Tax Rates Effective 7/1/01 [EGTRRA Sec. 101; IRC Sec. 1(i)(2)]

Planning Tip: Income shifting from family members with higher income to those 14 or older with lower income can save on taxes. Consider income postponement to a lower tax rate year. Consider accelerating expenses.

Phase-out of Personal Exemptions: Starting with tax year 2006, the limit on itemized deductions and the personal exemption phase-out are both reduced to 1/3 and in 2010 they are repealed.

Planning Tip:  This may push higher income taxpayers into AMT taxes as the regular tax is reduced while the AMT stays the same. Those who were subject to AMT would see no change because AMT is still calculated without regard to itemized deductions and personal exemptions.

Marriage Penalty Relief: The standard deduction for married couples filing a joint return is increased to twice the standard deduction of a single individual and the 15% tax bracket is increased for joint returns to twice that of single returns. This is regardless of whether both spouses work and will be phased in over 5 years and 3 years respectively after 2005. In 2005, the standard deduction is eliminated for single filers and replaced with a single filer standard deduction.

Planning Tip:  This change will have a greater effect on lower income taxpayers since most higher income taxpayers itemize their deductions. After 2005, "married filing separately" may have a greater combined standard deduction than a "married filing jointly" because of the new single filer standard deduction.

Alternative Minimum Tax Relief: This alternate tax system has never been adjusted for inflation so more and more taxpayers are being effected by it. EGTRRA increases the exemption but this relief is only from 2001 to 2004 as follows:

This exemption is phased out under prior tax law when alternative minimum taxable income (AMTI) for joint filers is between $150,000 and $330,000 and for single filers is between $112,500 and $247,500. Again, after 2004 this exemption increase of $4,000 and $2,000 is revoked.

Planning Tip:  So much for tax relief for the high income earners. The AMT nullifies the tax relief for high income earners and it will become a lightening rod for future reform proposals.

Corporate Estimated Tax: Now due the first of October instead of the last of September so the revenues can be included in the Federal Government's new fiscal year.

Estate, Gift and Generation Skipping Transfer Tax Reductions: The reduction of tax rates for death, gift and GST taxes are shown below. Estate and GST taxes are repealed in 2010.

The State Death Tax Credit will be reduced by 25% this year, 50% in 2003 and 75% in 2004. In 2005, the state death tax credit will be repealed and replaced by an estate tax reduction for any estate taxes paid to a state.

Stepped-up Basis: A gift retains the same basis to the donee as it had in the hands of the donor. Transfer after death creates a new basis equal to market value at death. In 2010, after the estate tax is repealed, the basis will be treated like a gift except (1) a $1.3 million basis increase (indexed for inflation), plus (2) a $3 million additional basis (indexed for inflation) increase for property passing to a surviving spouse. Total basis transferred to surviving spouse is $4.3 million.

In a trust, the executor will have discretion to determine which assets receive the basis increase. Retirement assets are not eligible for a basis increase nor are gifts received three years prior to death. The estate or beneficiaries can still use the $250,000 exclusion for gain on the sale of their residence.

Planning Tip:  If you have a large estate and you must die, best time for your heirs is to die in 2009. Seriously, there are some great estate planning issues here. For example, the increase in the Gift Tax Credit to $1,000,000 this year allows additional gifts removing any future appreciation in the gifted property from your estate. Also, taxable gifts are probably not a good idea due to the yearly increases in the estate tax credit. Annual exclusion gifts, payment of grandchildren's tuition and medical expenses, GRATS, Family Limited Partnerships and Life Insurance Trusts are techniques that still can be used.

Education Funding: The Education IRA [EGTRRA Sec. 401; IRC Sec. 530] annual contribution has been increased to $2,000 and the definition  has been expanded to include elementary and secondary school expenses. The phase out has been increased for a joint return to between $190,000 to $220,000. 

Qualified tuition programs [EGTRRA Sec. 402; IRC Sec. 529] or Section 529 plans are extended to private schools and universities who can now set up their own prepaid tuition plans. The distributions for higher education costs of both contributions and earnings are now tax exempt. For new private institutional plans, the distributions are tax-exempt after 2004.  

Employer-provided educational assistance [EGTRRA Sec. 411; IRC Sec.127] has been made permanent up to $5,250 and includes graduate-level courses such as law, business, medical, or other advanced degrees.

"Above the Line" qualified higher education expense deduction [EGTRRA Sec. 431; IRC Sec.222] is now available for qualified tuition and related expenses subject to modified adjusted gross income (not phase-out) limits. But, the whole provision is repealed in 2006.

Child Related Taxes: Child Benefits have been improved. The child tax credit will double to $1,000 per child over 10 years and can now be claimed as a credit in AMT calculations. Child care and dependent care is increased in 2003 to 35% of expenses up to $3,000 per dependent or $1,050 for one dependent and $2,100 for two or more. The adoption credit increases in 2002 to $10,000 for all children with an phase-out of $150,000 to $190,000.

Pension and IRA Provisions: The annual contribution limits increase and a new "Roth 401(k)" is established. Catch-up Provisions have been added for those aged 50 and older at the end of the tax year.

Elective deferrals are increased for defined contribution plans.

Increased benefit and contribution limits for qualified plans. [EGTRRA Sec. 611; IRC Secs. 401(a)(17) and 415]  

Defined contribution plans had contribution limits of 25% of includible compensation but it is now increased to 100%. Section 457 were also increased from 33 1/3% to 100%. For example, this increases the Section 457 plan annual contribution limit from $8,500, or 33 1/3 of includible compensation, to $11,000 or 100 percent of includible compensation in 2002. Vesting is now faster with 100% after 3 years of service or 20% after the second year of service with 100% vesting after six years of service.

Rollovers for post 2001 distributions from qualified plans, IRA, Section 403(b), and Section 457 plans can be made to any other plan. 

Top-Heavy Provisions: Eased rules now define a key employee as one who in prior year was (1) an officer with compensation in excess of $130,000 (adjusted for inflation in $5,000 increments), (2) a 5% owner, or (3) a 1% owner with compensation in excess of $150,000.    

Sunset Provision: In order to pass the Senate over Democratic opposition, the Bush Administration had to avoid the Byrd Rule which is an internal Senate rule that requires a 2/3 vote for revenue (tax) bills with a term over 10 years. Thus, the EGTRRA is set to expire by December 31, 2010 unless renewed. 

We strongly suggest you contact your Congressional representative and urge that EGTRRA, as complex as it is, be made permanent.

College Funding I Tax Tips I Real Estate I Mortgages

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