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. (The exhibit on below shows the phase-in of some tax rate changes for 2001 to 2006 and beyond.)
So, who wins? A number of factors will decide who will win, lose or draw. Whether they earn $1 million or $12,000 in 2001, taxpayers will get a $300 tax benefit in the form of an advance refund check ($600 for married filing jointly, $500 for head of household). This refund comes from the introduction of the 10% tax rate and is intended to jump-start the economy. Starting in July 2001, however, some clients will get more than others.
Digging deeper. Figuring out winners and losers by running the numbers based on the new tax rate schedules is the easy part. The far more complicated task CPAs face is assessing the relative importance lower rates will have in driving future tax strategies. Here is a short list of some of the areas accountants should review:
Itemized deductions, personal exemptions and the AMT. Beginning with the 2006 tax year, the provisions of the current law that restrict the value of itemized deductions and personal exemptions will be reduced by one-third; they will be reduced by two-thirds in 2008. Beginning with 2010, the restrictions no longer will exist. The new law also softens—at least temporarily—the bite of the alternative minimum tax (AMT), which tends to affect higher-income taxpayers more than others. In calculating potential AMT liability, taxpayers can take advantage of generous AMT exemption amounts. Beginning with 2001, the bill increases the exemptions by $4,000 for joint filers and $2,000 for everyone else. But the relief ends for tax years beginning after December 31, 2004, unless a future Congress decides to extend it. Ironically, even during the 2001 to 2004 period, the reduced income tax brackets the new law mandates will serve to lower many taxpayers’ “regular” tax liability below their AMT liability. This will cause the legislation’s AMT relief merely to halt the increase in taxpayers subject to the AMT until after 2004, rather than significantly lowering the number subject to it. Starting in 2005, the number of taxpayers subject to AMT is likely to resume its rapid increase. MARRIAGE, EDUCATION AND CHILDREN In addition to the basic income tax rate cuts, the 2001 act includes changes in joint-filer benefits and tax cuts for education savings and child care. As a result, the complexities of determining a client’s tax obligations will continue to increase. Marriage penalty relief. When the marriage penalty relief finally arrives, it will provide joint filers with a standard deduction twice that for single filers, phased in over a four-year period starting in 2005 and ending in 2008. Relief also will come in the form of an expanded 15% bracket equal to twice that of single taxpayers over the 2006 to 2008 period. Although the expanded 15% tax rate will benefit all couples, those who usually itemize instead of taking the standard deductions (statistically, this group includes most taxpayers above the new 25% tax bracket) should not expect marriage penalty relief to bring a substantial reduction in their tax bill. Education incentives. The new legislation greatly expands the role education IRAs can play in future family savings strategies as a result of a dramatic increase in the contribution limits, starting in 2002, to $2,000. Also starting in 2002, contributions will be allowable not only from individuals but also from corporations, tax-exempt organizations and other entities. Taxpayers now can make contributions until April 15 of the following year, rather than the current December 31 cutoff. Congress also has broadened the universe of those who may contribute to an education IRA. The contribution phase-out range for joint filers jumps to double that of single filers and is $190,000 to $220,000. Education IRAs now are available to pay for elementary and secondary school tuition—public and private—as well as the costs of higher education. Some taxpayers also stand to benefit from other education provisions in the bill, including an above-the-line college tuition deduction and an enhanced student-loan deduction. CPAs and their clients facing college education expenses will need to plan carefully to get maximum benefits from these incentives due to varying eligibility requirements, income phase-outs and other qualifications. Child tax credit. The new law doubles the current child tax credit to $1,000, phased in over 10 years, starting in tax years beginning after December 31, 2000. In addition, the law allows taxpayers to claim the credit against the AMT permanently and repeals the AMT offset of refundable credits. Retroactive application increases the credit, currently $500, to $600 for 2001. DEATH AND TAXES Longer-term aspects of the legislation’s impact on clients, particularly in areas such as estate and retirement planning, become even more complicated. Under the new legislation, estate tax “repeal” has become estate tax “complexity and uncertainty.” Some in Congress claim they have repealed the estate tax. More precisely, however, the new law gradually increases the estate tax exemption (more slowly in the earlier years) from $1 million to $3.5 million through 2009 and then repeals the estate tax for just one year—2010. Due to budgetary restrictions, the new law allows the current estate tax rules, rates and exemptions to come back in force in 2011. CPAs and attorneys not only will have to do some complex planning because of the law changes over the next 10 years but also will need to address the 2001 act’s immediate impact on estate plans, especially marital and family trusts, as a result of the increase in the exemption amount from $675,000 this year to $1 million next year, as well as the repeal of the qualified family-owned-business deduction starting in 2004. Without a crystal ball, it will be virtually impossible for estate planners to predict what tax rate and provisions will apply in the year a client dies. In the meantime, some wealthy clients may require an annual estate plan to take full advantage of the changes applicable to that year. At the very least, CPAs should encourage all clients to review their current estate plan before yearend and at least annually thereafter over the 10-year phase-in period. Modified carryover basis. To complicate matters further, in 2010 when estate taxes are fully repealed for one year, a modified-carryover-basis rule immediately goes into effect. At that time, death becomes an income tax problem. The basis of assets received from a decedent will carry over from the decedent, rather than be stepped up to fair market value at the date of death (or alternate valuation date) as is now the law. With proper planning, two exceptions will help many estates:
Not all property is eligible for an increase in basis. Property a decedent acquired by gift from a nonspouse less than three years before death is excluded (to prevent “gifts” of low-basis assets in anticipation of stepped-up basis). Similarly, property that constitutes a right to receive income in respect of a decedent is excluded. Stock in foreign investment and personal holding companies also is ineligible for a basis increase. Finally, in situations where there is no surviving spouse, reliance on only the $1.3 million exemption—especially after inflation does its work for 10 years—will not adequately protect a large number of estates from carryover-basis problems. Hypothetically, real estate or other assets that remain in a family for generations will require decades of accurate basis records. Without accurate records, clients will find the IRS winning basis cases in court on the burden-of-proof issue, thereby keeping basis low and taxing such assets at an artificially high rate. Since it is unclear now if these basis rules will ever go into effect, CPAs and their clients should not spend too much time worrying about or planning for them until it becomes clearer what actually will happen with estate tax repeal over the long term. Partial gift-tax remains. To prevent the significant use of gifts to transfer property with a lower tax basis from higher-to-lower-rate taxpayers, the 2001 act retains a modified gift tax. Starting in 2010, gifts in excess of a lifetime $1 million exemption will be subject to a gift tax equal to the top individual income tax rate at that time. State estate-tax relief. Creating even more problems on the state level, the state death-tax credit allowed against the federal estate tax will be reduced by 25% in 2002, 50% in 2003, 75% in 2004 and completely repealed thereafter—replaced by only a deduction for death taxes. Many states depend on the state death-tax credit as a significant source of revenue. RETIREMENT SAVINGS AND PENSION REFORM Retirement savings incentives and pension plan reform make up a significant part of the new bill. Reform in total weighs in at a cost of approximately $50 billion, and retirement savings incentives, including expansion of IRAs and 401(k) plans, are projected to cost $40 billion. The increased contribution limits and tax-favored savings options will likely leave many taxpayers bewildered by the choices and requiring assistance to make intelligent decisions. Among the more popular changes the new legislation makes to qualified plan and contribution limits are these:
NOT SO EASY While the new tax legislation significantly overhauls the
existing system, it is by no means tax simplification. As a
result, tax planning will be anything but easy for CPAs in
the coming years. But while clients may focus on the refund
checks they already have begun receiving, CPAs would be
better off spending time gaining a thorough understanding of
the new legislation’s deductions, credits, estate tax and
pension reform aspects—and their timing. This will enable
practitioners to help clients make the best plan for their
future financial circumstances and minimize their tax
obligations. | |||||||||||||||||||||||||||||||||||||||||||||||
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. 
t 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. 
Taxpayers who remain in the 15% bracket will
get no further benefit. 
