PricewaterhouseCoopers Guide to the New Tax Law

Chapter 1 The New Law's Key Provisions The mood was quietly jubilant in the East Room of the White House as President George W. Bush signed the $1.35 trillion tax cut of 2001. While a Marine Corps band played "Hail to the Chief," the president used a different pen to write each letter of his name, then handed the pens to the key Republican and Democratic legislators whose support had turned the bill into law. "Across-the-board tax relief does not happen often in Washington, D.C.," the president said. "In fact, since World War II, it has happened only twice: President Kennedy's tax cut in the sixties and President Reagan's tax cuts in the 1980s. And now it's happening for the third time, and it's about time." Celebration was surely in order: Any tax relief is welcome. Yet the Economic Growth and Tax Relief Reconciliation Act of 2001 was more than a tax cut. It was a huge and complex changing-of-the-rules of the economic game. For informed citizens, the Tax Act of 2001 offers opportunities to plan for the changes due to occur in the next decade. They can take advantage of each provision as it phases in (and sometimes phases out), adjusting their investments and accelerating (moving into an earlier year) or deferring (delaying to the following year) their income and deductions to keep the greatest possible share of income for themselves and their families. For such taxpayers, the new law may affect their entire economic lives. It will surely alter the way they invest their money, the way they save for their children's education and their own retirement, and the way they write their wills and structure their estates. Their first step, however, must be to achieve an understanding of the coming changes and how they will work. This book aims to make that task as painless as possible. In this chapter we will begin by discussing the law's provisions in each of four main areas: 1. Rate Reductions, Tax Credits, and Deductions All taxpayers will benefit from a new 10 percent bracket, which was carved out of the old 15 percent bracket. For married couples, the new tax rate applies to the first $12,000 of taxable income and will save them as much as $600 a year. In higher brackets, tax rates will fall in stages over the next five years. The top rate of 39.6 percent, paid by the top 1 percent of taxpayers, will fall to 35 percent; the 36 percent rate to 33 percent; the 31 percent rate to 28 percent; and the 28 percent rate to 25 percent. The child credit will rise in increments to $1,000, and the credit for child care expenses will also increase. Limits on personal exemptions and itemized deductions, which were formerly imposed in stages as income rose, will be phased out by 2010. There will be limited relief from the Alternative Minimum Tax (AMT), although this relief will not apply after 2004. And married people who pay more tax than they would as singles will get some relief, beginning in 2005. 2. Education Reforms In 2002, the maximum contribution that can be made to an educational Individual Retirement Account (IRA), now called a Coverdell Education Savings Account, will quadruple to $2,000 in after-tax money. Income from these accounts can be withdrawn tax-free to pay for school expenses, including tuition for private and parochial schools and expenses for state-approved homeschooling, as well as for college. The so-called Section 529 plan, for parents saving for tuition and expenses at colleges and universities, will expand to include plans of private institutions. Congress also increased the deductibility of interest on student loans and created a short-lived deduction for up to $4,000 in college tuition for couples earning less than $130,000. 3. Retirement Plan Changes The law provides major new incentives for retirement savings. The Roth IRA, which is funded with after-tax money and offers tax-free withdrawal of gains,Kurtzman, Joel is the author of 'PricewaterhouseCoopers Guide to the New Tax Law' with ISBN 9780345451385 and ISBN 0345451384.