After hearing so much about the new federal tax law, many people want to know how it will affect them personally.
With the signing of this law, there will be many changes to the tax codes. One of the most notable ways these new tax laws will be affecting you is with a reduction of the individual income tax rates that begins this year.
To begin, a new 10 percent tax rate has been carved out of the current 15 percent bracket that applies to the first $6,000 of taxable income for individuals, and $12,000 for couples filing joint returns.
Taxpayers who filed income tax returns for 2000 will receive a check issued by the U.S. Department of the Treasury – $300 for individual taxpayers and $600 for married taxpayers filing a joint return.
In addition to this new 10 percent rate, the other federal tax rates will also be reduced beginning Sunday, July 1, and will be gradually reduced each year through 2006.
For example, the current maximum rate of 39.6 percent will be reduced to 35 percent in 2006, with all tax bracket rates being similarly adjusted downward over time.
The 2001 tax law changes will also affect IRAs, SIMPLE plans, SEPs, and 401(k)s. The maximum contribution to a traditional or Roth IRA is currently $2,000 for individuals. This amount will increase to $3,000 in 2002, and then gradually increase to $5,000 in 2008 and thereafter. After 2008, the $5,000 limit will increase for inflation in increments of $500.
One thing that’s great news for many taxpayers age 50 and older is that they will be able to make additional “catch-up” contributions to their plans beginning in 2002. The catch-up amounts will be an additional $500 in 2002 through 2005, and $1,000 per year in 2006 and thereafter. The catch-up can be made to either a traditional IRA or a Roth IRA.
Similarly, contributions to SIMPLE plans will eventually increase to $10,000 in 2005, beginning with a $7,000 contribution starting next year. As with the IRA, these limits will also increase for inflation, and taxpayers age 50 and older will be able to make additional catch-up contributions.
Finally, SEP contribution limits will increase beginning in 2002 to the lesser of 25 percent of compensation, or $40,000, indexed for inflation.
In addition, the amount of compensation or earnings that can be taken into account will also increase to $200,000 in 2002. As a result, for 2002, the maximum SEP contribution will be $40,000.
As for 401(k)s, starting in 2002, employees will now be able to contribute up to $11,000 into their 401(k) plans, up from $10,500 this year. This limit will increase $1,000 each year to reach $15,000 in 2006.
And once again, taxpayers age 50 and older will be able to make additional catch-up contributions, while the limit will increase based on inflation after 2006.
The Economic Growth and Tax Relief Reconciliation Act of 2001 also affects other retirement funding vehicles, including pensions, and rollovers of Section 457 Plans.
For instance, maximum contributions to money purchase and profit-sharing plans will increase from $35,000 this year to $40,000 next year.
Finally, distributions from Section 457 plans in 2002 and thereafter can be rolled over into IRAs. Also, distributions from qualified plans, 403(b) plans and government 457 plans will be eligible for rollover to any of the other types of plan, provided the plan allows rollovers.
In addition, starting in 2002, after-tax contributions may also be rolled over to an IRA or another type of plan.
Remember the Education IRA introduced with the Taxpayer Relief Act of ’97? It’s been renamed the “Education Savings Account,” and has been modified to enable individuals to put away greater amounts of tax-advantaged money for the education of their children or grandchildren.
The original savings plan only enabled individuals to put away $500 per year. Beginning in 2002, the annual contribution limit to an Education Savings Account will be increased to $2,000 per child.
Among the other improvements to the Education Savings Account, distributions will be allowed to cover school expenses from kindergarten through high school – not just higher education expenses.
The phase-out of contribution eligibility for married taxpayers filing jointly will begin at $190,000 of AGI. Also, taxpayers will be able to postpone annual contributions until the next April 15, as has been the case for traditional IRAs.
Taxpayers will now be eligible to make a contribution to an Education Savings Account and a Qualified Tuition Plan – also known as the Section 529 Plan – in the same tax year. More importantly, distributions from 529 plans will be free of federal income tax after 2001.
There have also been changes to estate taxes. First, the estate tax exemption will rise from $675,000 this year to $1 million in 2002, and will increase gradually to $3,500,000 in 2009. But the best of all, estate taxes are scheduled to be totally eliminated in 2010. Also, beginning in 2002, the maximum marginal estate tax rate will be reduced. Basically, the rate drops gradually from 50 percent in 2002 to 45 percent beginning in 2007.
While the annual gift tax exclusion of $10,000 stays the same, the gift tax lifetime exemption rises to $1 million in 2002, and stays there. Meanwhile, the gift tax rates will gradually decline. However, it’s important to note that the gift tax will not be repealed in 2010.
The new tax law will offer a great number of opportunities for individuals and small businesses to save money and plan for their future.
Darren Schneck is a financial advisor in the Kukui Grove Professional Village offices of Morgan Stanley Dean Witter. For more information, please contact him at 245-6927.
