Income Tax Changes:

The much touted income tax reduction is a very slow reduction in the tax rate. In 2001 the tax bracket is cut by 0.5% and the child credit increased by $100. Big deal.

Actually, the first $6,000 of taxable income for a single person ($12,000 for a married couple), gets a 5% reduction worth $300 or $600. But above those amounts, the 2001 rate reduction is 0.5%.

If you make a million, the 0.5% cut is worth $50,000. A rate reduction obviously saves money for taxpayers; the more you make the more you save.

So if you made $6,000 ($12,000, if married) or more (taxable) last year, your tax was at least $300 ($600 if married) last year. If you make the same amount this year, your tax will be at least $300 ($600 if married) less this year.

The politicians thought about this and figured that if they issued advance tax refunds we would reelect them, after we rush out and spend our $300 / $600 checks, stimulating the economy and creating world peace.

Getting an advance refund of $300 seems more exciting than the reality of the $6 per week it works out to. That would almost pay for lunch once a week.

Here are the details:

The individual income tax rate drops the lowest rate to 10% from the old 15% bracket, effective retroactively to January 1, 2001. The 10% rate applies to the first $6,000 of taxable income for single filers, the first $10,000 for heads of households, and the first $12,000 for joint filers. Since this new rate is five percentage points less than the former lowest rate, and applies retroactively, the effect will be to reduce individual federal income tax for 2001 by a maximum of $300 for single filers (5% of $6,000), $500 for heads of households (5% of $10,000), and $600 for joint filers (5% of $12,000).

So if you made at least $6,000 (single) or $12,000 (joint) taxable income, you will get these refunds.

The whole idea, small as it is, makes some sense if you got a refund (or "broke even") this past April 15. But what if you owed last April? Are they going to send you an advance refund? If they send it, it means you will owe an extra $300 / $600 this coming April 15!!

Phased-in Individual Income Tax Rate Cuts

Besides creating the new 10% bracket, Congress reduced the other tax brackets, beginning after June 30, 2001. The wage withholding tables will be revised accordingly.

The initial reduction will be one percentage point. Thus, the 39.6% rate will be reduced to 38.6%, the 36% rate to 35%, the 31% rate to 30%, and the 28% rate to 27%.

But since this is effective mid-year, it really means a half-point drop for the year as a whole.

Further reductions are to occur in succeeding years. Finally, in 2006, the tax brackets are to be 10%, 15%,25%,28%,33%, and 35%. Unless they change the law before then!

These reductions do not help taxpayers in the AMT.

Alternative Minimum Tax (AMT) Relief for Individuals

The legislation provides temporary , but immediate, relief from the individual alternative minimum tax (AMT) by increasing the exemption to $49,000 for joint filers (a $4,000 increase), $24,500 for married taxpayers filing separately (a $2,000 increase), and $35,750 for other individuals (a $2,000 increase) in 2001 through 2004.

This saves married AMT Taxpayers about $1,000.

Other provisions in this legislation, although not directly affecting the AMT, eliminate its adverse impact on the child tax credit, the adoption credit, and the earned income credit.

Tax Benefits Relating to Children

The new law covers four broad areas relating to children. Only 1 is worthy of note:

Child Tax Credit. 2001 increase = $100. The legislation retroactively increases the child tax credit for 2001 from $500 per child to $600 per child. The $600 limit is to apply through 2004, then increase in small steps until reaching $1,000 in 2010.

Also provided are:

Adoption Expenses. The legislation permanently extends both the adoption credit and the exclusion for employer-provided adoption assistance, which were scheduled to expire after this year, and increases the maximum amount of each from $5,000 to $10,000. Perhaps more important for many taxpayers, however, is that it raises the income level at which the benefits begin to be phased out to $150,000 (versus $75,000 in 2001).

Dependent Care Credit. The legislation also provides more generous dependent care credit limitations that will increase the maximum credit for many taxpayers, but these provisions do not take effect until 2003.

Marriage Penalty Relief

The new law also promises relief from the "marriage penalty," but most affected taxpayers will have to wait until 2005 to benefit.

One provision will increase the standard deduction for joint filers by making it twice the amount available to single filers. Another provision will stretch the 15% bracket for joint filers to twice the size for single taxpayers, thus taxing a greater portion of joint filers' income at 15% before subjecting their remaining income to higher rates. These provisions will not begin to take effect, however, until 2005. The standard deduction provision is to be phased in over a five-year period and the 15% bracket increase over a four-year period.

A provision that will begin to take effect in 2002 (and be fully phased in after 2007) will increase the earned income credit (EIC) available to joint filers by increasing the earned income phase-out amount. Another provision taking effect in 2002 will simplify the EIC computation.

A more targeted "marriage penalty"-related provision, which also takes effect in 2002, increases the income phase out range to permit more joint filers to qualify for "Education IRAs," discussed below.

Education Provisions

Education IRAs. Beginning in 2002, the legislation significantly expands and liberalizes the "Education IRA" provisions.

• The most notable change is an expanded definition of tax-free "qualified education expenses," formerly limited to post-secondary education, that includes similar expenses (e.g., tuition) for attending elementary and secondary schools. The new law also:

• Increases the annual contribution limit to $2,000 per beneficiary (from $500); and

• Increases the phase out range for joint filers to twice the amount for singles, thus making the phase-out range $190,000 to $220,000 of "modified adjusted gross income."

Qualified Tuition Plans. Also effective in 2002, the legislation contains several provisions liberalizing the rules governing these plans, including a provision that allows funds to be rolled over from one plan to another plan maintained for the same beneficiary .The new law also extends this program, currently restricted to state-sponsored plans, to educational institutions (which may be private institutions) meeting certain requirements. Tax-free distributions from private plans, however, will not be available until 2004. Also, tuition credits or certificates will be available from private plans, but such plans will not be able to receive contributions to a savings account.

Employer Provided Educational Assistance. The legislation makes the exclusion, which was scheduled to expire at the end of this year, permanent, and extends the exclusion to graduate level courses beginning after December 31, 2001.

Student Loan Interest Deduction. Beginning in 2002, the new law:

• Increases the income phase-out range for eligibility, currently set at $40,000 to $55,000 of "modified adjusted gross income" for single filers and $60,000 to $75 000 for joint filers. The new phase-out ranges will be $50,000 to $65,000 (single filers) and $100,000 to $130,000 (joint filers), with inflation adjustments after 2002; and

• Eliminates the rule that limits the deduction to interest paid during the first 60 months in which interest is required.

Above-the-Line Deduction for Qualified Higher Education Expenses. Under this temporary provision, applicable from 2002 through 2005, eligible taxpayers can deduct "qualified tuition and related expenses," as defined for purposes of the HOPE credit, without having to itemize or be subject to the "miscellaneous itemized deductions" limitation. The maximum deduction is $3,000 in 2002 and 2003 and is limited to taxpayers having adjusted gross incomes (as specially defined) of up to $65,000, or, for joint filers, $130,000.

Remember, further changes in the rules are almost a certainty.

"Sunset" in 2011? One final aspect of the legislation merits comment. Technically, the changes made by the new law will cease to apply after 2010! This highly unusual provision was included to insure technical compliance with the federal budget law. The lawmakers obviously assume that this provision will be eliminated in future legislation.