Income and Corporate Tax Provision of the 2001 Tax Act

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Tax relief:

Is your ship coming in?

On May 26, 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (Act). President Bush signed the bill into law on June 7, 2001. The popular and financial press has covered many aspects of the Act, from the repeal of the estate tax to the effect of the alternative minimum tax (AMT). Taxpayers can even estimate their new tax liability at several websites and contemplate how to spend the savings.

The Act reduces taxes over a 10-year period, but it is heavily back-loaded: many of its more significant tax reductions come into effect after 2006. In addition, the Act has a sunset provision that repeals all of the tax reductions as of January 1, 2011, unless Congress takes further action before then.

Additional uncertainty stems from increasing concern over whether the projected surplus that would fund the tax reduction will actually occur. The slowing economy could reduce federal tax collections and motivate Congress to rescind some of the recent tax cuts in order to avoid budget deficits. Congress has found it difficult to restrain its own spending and has initiated additional program expenditures that will also erode the projected surplus. In addition, the Medicare and Social Security surpluses have been effectively removed from current budgetary considerations. Although taxpayers will enjoy some immediate tax reductions, they should also be aware that future planned reductions still hinge upon budgetary considerations and political changes, such as the shift in the balance of power in the Senate.

Several features of the Act complicate tax planning for individuals at all income and wealth levels. The phase-in and sunset provisions for the estate tax repeal pose serious problems for planning wealth transfers. In addition, many of the tax reductions slated for the 2004-2006 period will not provide as much relief as expected because the AMT, which was not changed as dramatically, will affect many additional taxpayers. Tax plannners will have to consider all these changes plus their repeal in 2011.

The following is an exposition of the principal provisions of the Act for personal income and corporate tax planning purposes. The estate, gift, and generation-skipping transfer (GST) tax provisions are covered in a separate article on page 26.

Personal Income Tax

The Act creates new tax rates that are lower for all individual taxpayers, including a new 10% bracket that will be in effect for a portion of all taxpayers' taxable income previously taxed at 15%. It applies to years after December 31, 2000, but will sunset after 2010. The 10% tax bracket applies as follows:

Rate Reduction Credit for 2001

The Act provides a rate reduction credit for 2001 to all individual taxpayers other than estates, trusts, nonresident aliens, or dependents as determined by their filing status on the 2001 tax return. Taxpayers are entitled to a credit for 2001 of 5% (the difference between the 15% rate and the 10% rate) of the amount of income that would have been subject to the new 10% rate. Taxpayers may not receive a credit larger than their income tax liability (determined after nonrefundable credits).

Most taxpayers will receive the credit in the form of a check issued by the Department of the Treasury. The amount of the check will be computed in the same manner as the credit, except that it will be based on tax returns filed for 2000 (instead of 2001). The Treasury anticipates that they will issue the checks before October 1, 2001, to taxpayers that filed timely tax returns in 2000. Taxpayers that filed late will receive their checks later in the fall.

The IRS is not authorized to issue any checks after December 2001. Taxpayers that have not filed their 2000 return in time for the advance refund to be mailed to them before January 1, 2002, may claim a credit, to the extent they qualify, on their 2001 return. …