Some Relief Comes This Year, Most Much Later

By KATHY M. KRISTOF

May 27, 2001 12 AM PT

TIMES STAFF WRITER

Nearly every American taxpayer will get a check this fall ranging from $300 to $600, thanks to the $1.35-trillion tax cut approved by Congress on Saturday.

However, the rest of the relief promised by the massive tax overhaul will take a lot longer to reach your pocketbook.

Some of the most generous tax cuts in the bill don’t start until 2002. Others, including most of the breaks aimed at ending the so-called marriage penalty, don’t kick in until 2005. Still other tax cuts phase in--and sometimes out--over 10 years, creating tax planning challenges for everyone.

“This isn’t a onetime event,” says Ed O’Connor, an expert on retirement and education savings at Merrill Lynch. “You can’t take one look at your affairs and figure you can deal with it. This is going to be an ongoing process.”

Many of the tax breaks in this bill are targeted to specific groups, such as married couples, parents of small children, people who are saving for college or retirement--even Holocaust victims. But because the breaks are phased in, some of today’s targeted beneficiaries may never get to take full advantage.

For instance, the child tax credit eventually will climb to $1,000 for each child under the age of 17. But today’s 10-year-olds will be too old to qualify for the credit by the time it’s fully phased in in 2010.

Who gets what and when? Here’s a look.

Tax Rates

The most contentious debate was over who gets lower tax rates, when they get them and how much lower their rates should go.

Congress opted for a two-tiered approach. A new 10% tax rate, applied to the first $6,000 to $12,000 earned by all taxpayers, goes into effect retroactively to the beginning of the year. Maximum benefit: $300 for singles, $600 for married couples and $500 for single parents.

To spur economic growth, the bill instructs the Treasury Department to send refund checks to American taxpayers by Oct. 1. However, those who filed late or got filing extensions may get their checks later.

Additional rate changes will kick in July 1. However, the changes will be incremental, with a 1 percentage point cut for all brackets starting this summer and another 1 percentage point cut starting in 2004. A third rate cut takes place in 2006.

The lower marginal rates could result in slightly bigger paychecks for all workers as the amount withheld for taxes shrinks starting this summer.

Estate Tax

Meanwhile, rumors of the death of the estate tax appear to be somewhat exaggerated. Although estate tax rates will decline and taxpayers will be able to bequeath more to their heirs on a tax-free basis--up to $1 million--starting next year, the estate tax will not expire completely until January 2010. Even then, the estate tax repeal is only legislated to last a year. Congress must either repeal the tax again by Dec 31, 2010, or the tax will revert to what’s in effect today.

Parents of young children

Under current law, parents of dependent children younger than 17 get a $500 tax credit per child. (A tax credit reduces your tax bill dollar for dollar, as opposed to a deduction, which reduces the amount of your income subject to taxation.)

The child tax credit will rise to $600 per child starting this year. The credit will rise to $700 in 2005, to $800 in 2009 and to $1,000 in 2010. Thus, a middle-income family with three young children will see its child tax credit rise this year from $1,500 to $1,800.

The bad news: If you earn more than set amounts, you still can lose all or part of this credit. The credit gets reduced by $50 for each $1,000 that your income exceeds $110,000 if married or $75,000 if single.

The good news: For working low-income parents, the credit will become partially refundable even if the parents pay no income tax.

The formula for figuring how much of the credit could be refunded is complex. However, a family of four earning $15,000 gets no benefit from the child tax credit today; under the new law this family will get a $500 check from Uncle Sam when it files its 2001 tax return, says Brenda Schafer, senior tax research coordinator at H&R; Block. Starting in 2005, this family’s refund would rise to $750.

Adoption credits

Tax credits that help defray the cost of adoption will be boosted and made permanent. The maximum credit, currently $5,000, will rise to $10,000 in 2002. Those who adopt special needs children will be able to claim a $10,000 tax credit in the year the adoption is completed, regardless of whether they had qualified adoption expenses.

Employer-paid adoption assistance of up to $10,000 per child will also be tax-free. But both breaks begin to phase out once a family’s income exceeds $150,000 annually.

Help with college costs

A series of complicated and sometimes mutually exclusive tax breaks launches in 2002 to help those saving or paying for college:

* Allowable contribution limits to education IRAs would be boosted to $2,000 from $500.

* Withdrawals from state-run college savings plans--a relatively new type of savings program that offers tax-deferred growth--will become tax-free if the money is used to pay for college. Currently, money withdrawn from a so-called 529 plan is taxed but at the child’s presumably minimal tax rate. (Withdrawals from college savings plans that are not sponsored by a state won’t become tax-free until 2004.)

* A deduction for qualified education expenses of up to $3,000 a year would be available to singles earning less than $65,000 and married couples earning less than $130,000, even if they don’t itemize deductions. However, those who claim this deduction couldn’t claim other existing education tax credits.

* Student loan interest deductions will be enhanced, allowing somewhat higher-income individuals to claim them and eliminating restrictions on how long they can be claimed.

Currently, you can only deduct interest on loans that you’ve been repaying for five years or less. Once you earn more than $40,000 when single or $60,000 when married, your ability to claim these deductions is reduced. Starting next year, interest deductions are available on all student loan payments--no matter how old the loan--for those with incomes of up to $50,000 when single and $100,000 for married couples.

The bottom line: “You have more options than you had before, but you have to make choices,” says Mark Luscombe, principal tax analyst with CCH Inc. in Riverwoods, Ill. “One of the [new] choices may give you better benefits, but you may have to pay someone to figure out which one that is.”

Marriage penalty relief

Dual-income married couples, who now often pay more tax than two singles with the same combined income, will get modest tax relief--eventually. This relief, which starts in 2005, will come on two fronts: An expanded 15% tax bracket and a larger standard deduction.

Among other things, two-earner married couples say they suffer under the current tax code because their standard deduction is less than twice the size of a single person’s standard deduction. Moreover, the income thresholds where higher tax brackets kick in for marrieds also aren’t at twice the level for singles. Consequently, if a dual-income couple were to live together rather than marry, they’d get bigger deductions and pay less tax.

To solve this, the standard deduction for a married couple filing jointly, which currently amounts to 160% of the standard deduction for singles, will rise to 174% in 2005. It will rise to 200% of the standard deduction for singles in 2009.

The 15% tax bracket for married couples will also eventually rise until it’s twice the 15% bracket for singles. These changes would save a relatively low-income couple up to $225 a year, says H&R; Block’s Schafer. High-income couples could save as much as $594 if they don’t itemize deductions. Married couples who itemize will get less benefit.

Retirement provisions

Allowable contributions to all types of retirement plans--401(k), 403(b), 457, individual retirement accounts and so-called Simple plans--will be gradually increased. And people over 50 can make bigger “catch-up” contributions starting next year.

Also, retirement plans for public employees, schoolteachers and employees of nonprofit organizations will become more flexible and portable.

In addition, starting in 2002, those earning less than set amounts will be eligible for a five-year program in which they can receive tax credits if they contribute to a qualified retirement plan.

The credit amount is staggered based on income and filing status. However, a married couple earning $30,000 or less who contributed $2,000 to an IRA could claim a $1,000 tax credit. If this couple earned $45,000, their tax credit would fall to $200.

Holocaust victims

Restitution paid to Holocaust victims, their heirs or estates after Jan. 1, 2001, will be excluded from tax.

Help for the well-heeled

High-income taxpayers will get some relief from both complexity and income taxes. That’s because deduction and personal exemption “phase-outs” that preclude those who earn more than set amounts from getting full credit for both itemized deductions and personal exemptions will be reduced or eliminated--but not until 2008.

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Tax Savings

One way the Bush tax cut affects almost every taxpayer is by gradually reducing tax rates. The savings for selected incomes--for a sample single filer and a married couple filing jointly--are shown below. The rebate checks this year are based on taxable income from the year 2000.

When It Counts

Timeline for the key provisions in the $1.35-trillion, 10-year tax cut plan that was approved by the House and Senate on Saturday.

2001

10% tax bracket created (applies to first $6,000 of annual taxable income for individuals, $12,000 for married couples).

As of July 1, other income tax rates drop from 39.6% to 38.6%; 36% to 35%; 31% to 30%; 28% to 27%.

Child credit increases to $600, from $500.

2002

Tuition deduction begins, with a $3,000 deduction allowed for individual taxpayers with less than $65,000 annual income ($130,000 for married couples).

Increase in annual contribution limits to IRAs begins.

Increase in annual contribution limits to 401(k)s begins.

Estate tax phaseout begins.

2004

Income tax rates drop another 1 percentage point.

College tuition deduction rises to a limit of $4,000.

2005

Child credit increases to $700.

Marriage penalty relief begins.

2006

Income tax rates drop from 37.6% to 35%; 34% to 33%; 29% to 28%; from 26% to 25%.

Increase in 401(k) contribution limit completed, reaching $15,000.