The recently enacted Economic growth and Tax Relief Reconciliation Act of 2001 offers a window of opportunities for tax planning. The Act changed various individual provisions effective over the next five to ten years, which makes tax planning almost imperative to maximize benefits. The key provisions of the Act includes marginal income tax reduction for individuals, marriage penalty relief, tax benefits relating to children, increased education incentives, increased 401(K) plan and IRA contributions, alternative minimum tax relief and estate tax relief.

Splitting and Postponing Income

With the individual income tax rates moving significantly lower in the next five years, splitting income with family members and postponing until the rates are fully phased-in become an important planning opportunity. The main attraction of the new law is the gradual tax rate reduction for individuals starting in July 1, 2001.

The current law has five individual rate brackets: 15%, 28%, 31%, 36% and 39.6%. The new law reduces the current rates by 3% to 4.6% over the next five years and introduces an additional tax bracket by sub-dividing the lowest bracket into two rates -10% and 15%. The introduction of the new 10% tax bracket makes family income splitting more attractive. Similarly, postponing income could save you as much as 3% to 4.6% tax over the next five years depending on your tax bracket. Postponing the exercise of non-qualified stock options could also serve as an effective planning strategy.

Apart from the concentration issue of your employer stock in your portfolio and the volatility and uncertainty in the market condition, you need to consider savings from tax rate reduction over the next five years when timing the exercise of your non-qualified stock options. In addition to timing the recognition of income, timing your itemized deductions becomes an important planning consideration with the new tax law.
If you are in a high tax bracket, the new law offers a hidden tax-cut through the gradual phase-out of the limitation on itemized deductions and personal exemptions from 2006 to 2010. For example, if you are planning to buy a more expensive home or planning a large contribution to your favorite charity, you need to consider the timing of these decisions to maximize the benefits.

Enhanced Education IRAs

The new law greatly expands the opportunities for leveraging education IRAs (now known as "education savings account") as an overall family tax planning strategy for more taxpayers. Starting in 2002, the new law increases the annual contribution limit from the current $500 to $2,000, and raises the adjusted the gross income ceiling for joint filers to $190,000-$220,000, twice the amount of single filers allowing more taxpayers to participate in education IRAs. Tax-free distributions from education saving accounts may now be used to pay for public and private elementary (including kindergarten) and secondary school expenses as well as for college education. Covered expenses include room and board, tutoring, computer equipment, uniforms, and extended day program costs. You now have until April 15 of the following year to make contributions to an education IRA.

Expanded Qualified State Tuition Programs

The new law expands the definition of qualified tuition programs and changes the tax treatment of distributions in your favor. Tuition programs may now be established by states as well as by private institutions of post-secondary learning. You will be able to exclude from gross income all distributions from qualified tuition programs provided you use them to pay for qualified higher education costs. For state sponsored programs, distributions are excludible from gross income starting in 2002. For private programs, distributions would be excludible starting in 2004. Roll over from one program to another will not be treated as a distribution.

Employer Education Assistance

Under the new law, employer provided education assistance up to $5,000 are permanently excluded from the employee's gross income for both graduate and under graduate studies for courses beginning in 2002.

Student Loan Interest Deduction

The new law repeals the dollar limit and the time limit of student loan interest deduction. It modifies the income phase-out threshold to allow more taxpayers to deduct student loan interest. It increases the income phase-out range to $100,000-$130,000 (from $60,000 to $ 75,000 for joint filers and to $55,000 to $65,000 (from $40,000 to $50,000) for singles effective for interest paid beginning in 2002.

New College Education Deduction

Generally, education expenses are not deductible unless the education qualifies as an employee business expense, but the new law introduces a temporary college tuition deduction beginning in 2002 and expiring after 2005 that may benefit certain taxpayers. For 2002 to 2003 the maximum allowable deduction is $3,000. You must meet the adjusted gross income threshold ($ 65,000 for singles, $130,000 for joint filers).

Estate and Gift Tax Relief

Under the current law, transfer of assets from one person to another is subject to three federal taxes -- gift tax, estate tax and generation-skipping transfer (GST) tax. Gift tax is imposed on the donor for gifts made during his lifetime. Estate tax is imposed on the value of the decedent's estate. GST tax is applicable to transfer of assets to a younger generation during lifetime or upon death of the transferor. Gift and estate taxes are unified so that one tax rate schedule ranging from 18% to 55% is applicable. A flat 55% rate applies to GST.

A unified credit can be used to offset gift and estate taxes. The unified credit essentially exempts transfers of a certain amount during the lifetime or upon death of the transfer. For 2001, the exempt amount is $675,000 for estate tax, and $1,060,000 for GST tax.

The new tax law creates numerous other opportunities and strategies to save you tax dollars. It also imposes layers of complexity due to various effective dates, phase-in dates and other provision. It will serve you well to be proactive and seek professional help with tax issues over the next few years.

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