C. K. Sea TAX ALERT

THE ECONOMIC GROWTH AND TAX RELIEF
RECONCILIATION ACT OF 2001

The Economic Growth and Tax Relief Reconciliation Act of 2001 (the Act) represents the largest tax cut in more than twenty years. The Act primarily benefits individuals through income tax rate cuts, marriage penalty relief, child tax credit increases, additional education incentives, retirement and pension reform, estate tax phase out. Some provisions are retroactive and others get phased in over a period of years.

Several new Congresses and at least one more President will have to decide the ultimate fate of the provisions of this Act, since all of the provisions expire at the end of 2010. It is anticipated that further tax legislation will be introduced later this year as well as during the next nine years. Thus, long-term planning will be complicated as a result of these uncertainties and the timing of many provisions.

This Tax Alert highlights most of the major provisions enacted. Although many of these changes are automatic, others require planning and action to maximize the benefits. C.K. Sea is committed to informing and guiding you through the complexities of the Act and how they may apply to your personal situation.

INDIVIDUAL INCOME TAX PROVISIONS

·  New Tax Rates

A new 10% individual income tax bracket is carved out from the existing 15% bracket. The 10% bracket will apply to the first $12,000 of income for joint filers and $6,000 for individuals. Refund checks for the tax year 2001 will be mailed starting in July 2001 to accelerate the benefit of the new 10% rate. The refund checks will be based on the individual's filing status for 2000 and will be $300 for single filers and $600 for joint filers. Other rate brackets also are reduced each year, beginning July 1, 2001, as follows:

·  Marriage Penalty Relief - phased in beginning in 2005 and mainly will benefit individuals who do not itemize since the relief is enacted by increasing the standard deduction and expanding the 15% bracket.

·  Itemized Deductions - under current law for 2001, total itemized deductions (other than medical, investment interest expense and casualty, theft or wagering losses) are reduced by 3% of the amount of adjusted gross income that exceeds $132,950 for joint filers. This limitation is being phased out by one-third in 2006 and 2007, two-thirds in 2008 and 2009 and is repealed fully in 2010.

·  Personal Exemptions - under current law for 2001, the deduction for personal exemptions is phased out ratably for joint filers with adjusted gross income over $199,450. This limitation is being phased out by one-third in 2006 and 2007, two-thirds in 2008 and 2009 and is repealed fully in 2010.

·  Alternative Minimum Tax (AMT) - the individual AMT is a separate tax calculation that disallows certain deductions, increases taxable income by certain adjustments, and carries a maximum rate of 28%. Many individuals have been affected by the AMT over recent years because of the difference between the ordinary rates and the 28% maximum AMT rate has decreased over the years. Under the Act, an increasing number of taxpayers will be subject to the AMT since ordinary rates are being reduced even further, but the AMT rates are not.

The only important change in computing the AMT is a modest increase in the exemption for a limited four-year period as follows:

·  Child Tax Credit - the current child tax credit of $500 increases to $600 in 2001 through 2004, to $700 in 2005 through 2008, to $800 in 2009 and to $1,000 in 2010. The child tax credit begins to phase-out at $75,000 of income for single individuals and $110,000 for joint filers.

·  Adoption Credit - the adoption credit is extended permanently and increases from $6,000 to $10,000 per child starting in 2002 and the income phase-out range doubles from $75,000 to $150,000.

·  Dependent Care Credit - employment-related expenses allowed in computing the dependent care credit are increased from $2,400 to $3,000 for one dependent (and from $4,800 to $6,000 for two or more dependents) starting in 2003.



RETIREMENT SAVINGS PROVISIONS

·  Individual Retirement Plans

The Act increases the amount that individuals can contribute each year to IRAs. The annual contribution will increase gradually from the current $2,000 limit to $5,000 by 2008. Amounts are indexed for inflation after 2008. The Act also allows workers age 50 and above to contribute an additional amount in an attempt to "catch up". The "catch up" payments either can be deductible or made to a Roth IRA if income limits are met.

·  Employer-Provided Retirement Plans

The new law will increase the amount an employee may contribute to his/her 401(k) and other employer sponsored plans. The annual contribution limit will increase for 401(k) and 403(b) plans from the current $10,500 to $15,000 by 2006. The contribution limit for 457 plans will increase from $8,500 to $15,000 by 2006, and all plans will be increased for inflation after 2006. As with IRAs, workers age 50 and above can contribute an additional amount in an attempt to "catch up. "

·  Roth Designated Contributions to 401(k)

Under current law, salary earmarked for 401(k) plans is exempt from tax until money is withdrawn. Under the Act, employees may elect to have all or part of their contribution subject to tax by designating it as a Roth contribution. If so designated, the contribution is not exempt from tax when made; however withdrawals from the Roth 401(k) will be tax-free upon retirement if certain requirements are met. This law is effective for tax years beginning after 2005.

·  Faster Vesting of Employer Matching Contributions

Accelerated vesting of employer matching contributions will allow employees to take full advantage of their employers' 401(k) plans fully after 2001. The options available are as follows:

·  100% after three years of service, or

·  20% after two years of service, 40% after three years, 60% after four years, 80% after 5 years, and 100% after six years.

·  Defined Benefit Plans - increase in the defined benefit dollar limit from $140,000 to $160,000 beginning in 2002 (then indexed for inflation in $5,000 increments).

·  Defined Contribution Plans - increase in the annual addition limit for defined contribution plans from $35,000 to $40,000 beginning in 2002 (then indexed for inflation in $1,000 increments).

·  Portability - The Act includes a number of provisions to enhance the portability of retirement accounts effective for distributions made after 2001. For example, pre-tax IRA account balances can be rolled over into any other type of retirement plan such as a qualified plan, 403(b) annuity or section 457 plan. Previously, these plans could not be commingled.



EDUCATION SAVINGS PROVISIONS

·  Education Savings Accounts

The annual contribution limit for Education IRAs, or Education Savings Accounts as they now are called, has been increased from $500 to $2000 beginning in 2002. Contributions can be made by individuals, corporations, tax-exempt organizations and other entities. Beginning in 2002, the income phase-out ranges are $190,000 -$220,000 for joint filers and $95,000 - $110,000 for other filers.

Distributions from these accounts will be tax-free as long as they are used to pay for qualified education expenses. The definition of qualified education expenses is expanded to include elementary and secondary school expenses, as well as public, private, and religious school expenses.

·  Qualified Tuition Programs

Qualified Tuition Programs, also known as Section 529 Plans, have been expanded. In addition to state universities, private universities and colleges will now be able to sponsor these pre-paid tuition plans. Rollover provisions also will enable taxpayers to move funds between plans.

·  Student Loan Interest Deduction

This interest deduction now is unlimited and will be available to somewhat higher income taxpayers. Beginning in 2002, the income phase-out range is $50,000 - $65,000 for single filers and $100,000 - $130,000 for joint filers. The Act repeals the limitation that only allowed the deduction for interest paid during the first 60 months that interest was required to be paid.

·  Deduction for Qualified Higher Education Expenses

An above the line deduction for qualified higher education expenses is available beginning in 2002 through 2005. In 2002 and 2003, single taxpayers with up to $65,000 in income and joint filers with up to $130,000 in income will be able to deduct $3,000. In 2004 and 2005, the income thresholds rise to $80,000 for single taxpayers and $160,000 for joint filers. Deductions of $2,000 to $4,000 will be available in 2004 and 2005 based on income.



ESTATE, GIFT AND GST PROVISIONS

·  Rates - The Act includes a reduction of tax rates, in addition to a long-debated provision - the eventual repeal of the estate and generation skipping tax (GST), albeit for only a one-year period in 2010. The gift tax was not repealed, although the exemption does increase to $1,000,000 in 2002. The combination of new complicated provisions, phase-ins, and the uncertainty of the estate and GST tax after the year 2010 sunset, all make wealth transfer planning even more intricate than before.

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Planning for estate and GST taxes under the Act will have to be done with an eye toward the future in three separate and distinct segments. They include, the phase-out period through 2009, the repeal year of 2010, and the year 2011 and beyond when we could revert back to a 55% rate and a $1,000,000 exemption, if Congress does not act to extend the repeal. Gift tax planning also will be complicated since the exemption increases to $1,000,000 in 2002, and gifts above that amount will continue to be subject to a gift tax, at reduced rates that phase-in over nine years.

·  Modification of Basis Step-Up

Under the current estate tax system, assets held at death get a stepped-up basis equal to fair market value on the date of death. Upon the subsequent sale of such assets, gain was computed using this stepped-up basis, rather than the decedent's historical basis. In 2010, this step-up in basis will have limited application.

Assets inherited from decedents dying after 2009 will have a carry-over basis, equal to the basis in the hands of the decedent before death, with limited modifications.

The modifications include a $1,300,000 step-up, which may be increased by certain losses, such as unutilized capital losses and net operating losses. Basis of assets transferred to a surviving spouse can be stepped-up by an additional $3,000,000. Considerable analysis of assets most appropriate for these allocations will be required.

·  Additional provisions include expanding the availability of installment payments of estate taxes beginning in 2002. This will allow estates and heirs to claim the income tax exclusion for gain on the sale of a principal residence, and phase-out of the state death tax credit by replacing it with a deduction for state death taxes paid.

·  New Reporting Requirements

To promote compliance with the carryover basis rules under the Act, there will be enhanced reporting requirements for gift and estate tax purposes. Non-cash gifts in excess of $25,000 and certain transfers of non-cash assets at death must be reported, along with the basis of the assets, the name and taxpayer identification number of the recipient and the amount of basis increase allocated to specific property.



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