Back

Summer Newsletter Volume I

THE NEW TAX BILL

Congress has delivered the baby Bush wanted. It was in a slightly lesser form than intended. It may be referred to as a shrub rather than a Bush. The cost is 1.35 trillion dollars over 10 years. Here are the provisions:

1. Tax Rates Will Decrease

• A new 10% bracket will be added for some taxable income that is currently taxed at 15%.
• This creates instant refunds for taxpayers who will receive checks in the mail from July - September based on the last two digits of your Social Security number.
• Single filers will receive $300, head of household filers will receive $500 and married filing joint filers will receive $600.

Other brackets decrease. Here is a sampling:

Present	2001	2006
28%	27.5%	25%
31%	30.5%	28%
36%	35.5%	28%
39.6%	39.1%	35%

• As you can see, the decreases start slow (1/2 of 1 percent this year) and will become 3% or greater decreases in all brackets by 2006.
• The highest rate will dip from 39.6% to 35%.
• Stealth taxes (i.e. loss of your deduction for itemized deductions and exemptions) will slowly disappear by 2009.

2. The Marriage Penalty is Relieved

• The standard deduction will be double that of single filers.
• The 15% bracket will be expanded for joint filers.
• The earned income credit will be more available.
• This relief does not phase in until 2005-2009.
• Single taxpayers living together who do not want to get married should start considering new excuses now.

3. Child Credit is Increased

• The credit doubles from $500 to $1000 by 2010.
• You get an extra $100 (now $600) for the year 2001.
• Adoption credits are significantly increasing ($10,000 in the Year 2002).
• Dependent care credits will rise from 30% to 35% on $3000 (not $2400) of qualified expenses. The floor is still 20%. This also is effective in 2002.

4. Education Options are Expanded

• Education IRA's are increased from $500 to $2000.
• Qualified tuition programs can now be established by financial institutions other than through states
• Above the line deductions for college costs will be added ($3000 in 2002 and 2003; $4000 in 2004 and 2005)
• Student loan interest deductions will have less restrictions and higher income phase-outs.

5. Estate Tax is Repealed

• $1 million in lifetime gifts
• Full repeal of estate taxes in 2010.
• The estate tax comes back in 2011 as if nothing happened if Congress does not act. (Yes that is very scary)
• Another problem with repeal is that you have to track basis on your estate assets except the first 3 million going to a spouse and there are other exceptions
• It is almost impossible to calculate the basis of assets in estates - this should be fun!
• The estate exemption would rise from the current $675,000 in 2001, to $1,000,000 in 2002 and 2003, to $1,500,000 in 2004 and 2005, to $2,000,000 in 2006 to 2008, to 3,500,000 in 2009 and finally repealed in 2010.

6. More Money in Retirement

• No change this year
• IRA contributions will increase from $2000 currently to $5,000 in 2008.
• Individuals aged 50 an older will be able to "catch up" with an extra $1000 by 2006.
• 401K's will increase from $10,500 currently to $15,000 in 2006.
• Defined contribution plans will increase form $35,000 currently to $40,000 in 2002.

Scary Stuff

• The recent shift in power back to the Democrats will lessen the opportunities for further tax reductions.
• If you are currently affected by the alternative minimum tax (AMT), these benefits could be negligible.
• AMT needs to be addressed. Write your congressional leader.
• If you don't owe tax currently, you won't be getting one of the checks from the government.

Conclusion

The bill hands out money to almost everyone. The big winners are taxpayers who are married, have children, going to school, adopting, or saving for retirement. Most everyone should receive more money back unless they don't currently owe or the alternative minimum tax kicks in. This bill creates more phase-ins and complications to an already outrageous tax code. Yes, it is business as usual for Congress. You may wish to call or e-mail us at the CPA Advisory Group to better understand the impact on your personal tax situation.

IRA/Pension Changes

Congress has the sense (and perhaps rightly so) that most people aren't saving enough for their retirement. As a result, the recent Tax Act includes numerous, generally favorable; changes related to IRAs and employer-provided retirement plans that are designed to encourage more retirement savings. Although a few of the new provisions don't take effect for several years, most come into play next January 1st. With that being only a short time away, we want to take a few minutes to summarize the major provisions effective next year and offer some suggestions on how you and your family might benefit from the changes.

IRA Contribution Limits Increase

For 2001, you're generally allowed to contribute to a traditional or Roth IRA the lesser of $2,000 or your earned income. (The year you reach age 70 Þ, traditional IRA contributions can no longer be made. In addition, Roth IRA contributions aren't allowed in any year your income exceeds $160,000 on a joint return or $110,000 on most other types of returns.)

If you're married and file a joint return, the IRA contribution limit is the lesser of $4,000 or your combined earned income (with no more than $2,000 going into either person's account). If your income is below a certain level (or you're not covered by a retirement plan at work), contributions to a traditional IRA are deductible.

Beginning next year, the $2,000 contribution limit goes to $3,000 (or double that amount on a joint return). If you'll be at least 50 by the end of next year, this limit is $500 higher. Thus, for 2002, a married couple filing a joint return who are both over age 50 by the end of next year and who have at least $7,000 of earned income can make a total of $7,000 of contributions to IRAs (with no more than $3,500 going to either spouse's account). This compares to the maximum of $4,000 they can contribute for this year.

The Tax Act, however, makes no changes to the income limits that determine whether your contributions to a traditional IRA are deductible. Nor did it change the $100,000 income limit for converting traditional IRAs to Roth IRAs or the limits for making annual contributions to a Roth IRA. In addition, traditional and Roth IRAs are still subject to one combined contribution limit. Thus, for example, if you're under age 50 and contribute $3,000 to a traditional IRA next year, you can't make any contribution to a Roth IRA even if you otherwise qualify because you've used up your full contribution limit for the year.

That brings us to our first planning tip. If you're eligible to contribute to both a nondeductible traditional IRA and a Roth IRA, go for the Roth-the earnings are not only tax-deferred (like a traditional IRA), they're tax-free if you leave them in the account long enough. In addition, if you get in a cash bind, your Roth IRA contributions can be pulled back out at any time without income tax or the 10% early withdrawal penalty.

If you're also eligible to make a tax deductible contribution to a traditional IRA, the decision on where to stash your annual contributions gets a little tougher. You'll generally want to go for the tax deductible traditional IRA if your current tax bracket is significantly higher than where it will likely be during retirement. However, if you expect your tax bracket to stay about the same or even increase during retirement, forgoing the current deduction and making a Roth IRA contribution may be more appealing.

Regardless of your tax rate now and later, the IRA distribution rules also tend to favor Roth IRAs. For example, if you think you might want to withdraw amounts before retirement (perhaps to fund your child's education or to start a business), a Roth IRA may be the way to go. A Roth IRA may also work best if you think you won't actually need the funds at retirement and instead would like to maximize the amount left to your heirs.

Elective Deferral Limits Are Also Going Up

This year you can put up to $10,500 into your employer's 401(k) plan; 403(b) annuity plan, or Salary Reduction Simplified Employee Pension (SARSEP) plan and reduce your taxable income by a like amount. (If your employer sponsors a SIMPLE retirement plan, the current deferral limit is $6,500.) The primary benefit of putting money into any of these plans is that you're helping your retirement nest egg grow and the deductibility of the contributions means Uncle Sam is picking up part of the cost.

The Tax Act raises the annual deferral limit for next year to $11,000, with an eventual increase to $15,000 in 2006. (The limit for SIMPLE plans goes to $7,000 in 2002 and eventually to $10,000 in 2005.) In addition, beginning next year, if you're over age 50 and your employer's plan allows it, you'll generally be able to defer up to an additional $1,000 into your employer's plan (up to an additional $500 for a SIMPLE plan) even if you otherwise would be limited on your deferrals because of the nondiscrimination rules. These so called catch up contributions rise to $5,000 by 2006 ($2,500 for SIMPLE). Thus, in five more years, those who are at least age 50 by that point potentially will be able to defer up to $20,000 ($15,000 + $5,000) of their salary into their employer's retirement plan-compared to the maximum of $10,500 that's allowed for this year.

That brings us to our second planning tip. If you're covered by a retirement plan at work where your employer matches at least a portion of the amount you contribute to the plan, you'll generally want to put in what's necessary to get a full match-before taking advantage of any of the increased IRA contribution limits we discussed earlier. It's hard to beat a matching contribution for pumping up your retirement account. And, as icing on the cake, the new law shortens the period over which employers can take back part of their matching contributions if you leave. Beginning next year, matching contributions must either be 100% vested at the end of three years or 20% vested after two years and an additional 20% vested per year for years three through six.

Other Favorable Changes

In addition to increasing the amount you can contribute to IRAs or defer into an employer's retirement plan-such as a 401(k) plan, the new law also made the following changes (all effective next year):

The compensation a retirement plan may take into account for the purpose of determining an individual's benefits under the plan is increased from the current $170,000 limit to $200,000. At the same time, the maximum annual amount an employer may contribute to a defined contribution plan on an individual's behalf goes from $35,000 to $40,000 (assuming certain other limitations are satisfied And finally, the new law relaxes some of the so called top-heavy provisions that can keep a employer's more highly paid employees (especially the owners) from fully benefiting under the company retirement plan. Taken together, these changes should allow more top-paid employees t receive additional tax-favored retirement benefits.

Owners of unincorporated businesses, partners, LLC members, and S corporation shareholder generally will be able to receive loans from their company's qualified retirement plan on the same terms as non-owner employees.

Individuals whose income is below a certain level will be able to claim a tax credit of up to $1,000 for making a contribution to an IRA or their employer's retirement plan. Thus, for example if your newly married son and daughter-in-law are just starting out and have $29,000 of income next year, they could each contribute $2,000 to an IRA (perhaps using funds partially gifted from you) and reduce their tax by a total of $2,000 (a $1,000 tax credit for each of them). In addition, if the contributions go in traditional IRAs rather than Roth IRAs, they could also claim a $4,000 deduction for the IRA contributions. The credit decreases as income rises and is completely phased out for taxpayers filing a joint return who have over $50,000 of income (the upper limit is $25,000 of income for most other individuals). In addition, the credit isn't available to (1) anyone under age 18 (2) a full-time student, or (3) someone claimed as a dependant on another person's return.

The law substantially improves the rules on rolling retirement money from one account to another, especially for employees of nonprofits and government entities. Thus, when you retire or leave one employer for another, you'll generally have more flexibility to move funds from your old employer's plan to a new employer's plan or to an IRA.

What's the Bottom Line?

The fact that Congress is offering you several new or improved ways to save for retirement is one thing. Actually taking advantage of the opportunities is another. The various new tax benefits may help some, but what most people really need in order to improve their retirement savings efforts is cold hard cash. Raising the contribution limit on IRAs and the elective deferral limits for 401(k) s, 403(b) s, SIMPLE, and 457 plans just isn't going to benefit those who already don't take full advantage of today's limits-unless they change their saving habits and free up more funds to put aside for retirement.

If you're frustrated by a lack of progress in saving for retirement or would simply like help making sure you're taking advantage of the tax-favored retirement saving options that will benefit you the most, please call us. We'd be happy to help you clarify your options and determine what works best in your situation.

Education IRAs Are Now Viable Savings Vehicles

Until now, most commentators were critical of Education IRAs, mainly because of the skimpy $500 annual limit on contributions. In many cases, account management fees ate up a good chunk of the investment returns because so little money could be put into play with these accounts.

Thankfully, that's no longer the case. Starting next year, you can contribute up to $2,000 annually to an Education IRA. If you have several children (or grandchildren}, you can contribute that much to individual accounts set up to benefit each. So, if you have three kids, you can sock away up to $6,000 every year. Account earnings are allowed to build up tax-free and can then be withdrawn tax-free to pay for the account beneficiary's college expenses. Of course, the contributions themselves are nondeductible (just like contributions to Roth IRAs}. So far, so good.

Even better, you'll be able to take tax-free Education IRA withdrawals to pay for elementary and secondary school (K-12} expenses starting in 2002. Eligible expenses will include tuition and fees to attend private and religious K-12 schools as well as costs to attend public K-12 schools. What kind of expenses can you cover? The rules are pretty liberal. Eligible items include books and supplies; computers, peripheral equipment, and software (as long as the program is primarily educational in nature}; room and board; school uniforms; transportation; academic tutoring; and even Internet access charges. In the case of computers and related equipment, it's okay if other family members use them as long as the Education IRA beneficiary also uses them during any year he or she is in school.

Starting next year, you will also be allowed to take tax-free withdrawals from an Education IRA in the' same year the Hope Scholarship or Lifetime Learning tax credit is claimed for the account beneficiary's college expenses. However, the same expenses cannot be used to claim both breaks. Starting with contributions related to the 2002 tax year, you'll have until April 15th of the following year to make your annual Education IRA contributions. This is the same deadline as for traditional and Roth IRA contributions. (Currently, Education IRA contributions must be made by the end of the year to which they relate.}

Finally, the adjusted gross income (AGI) phase-out range that limits Education IRA contributions for high- income taxpayers will be increased to between $190,000 and $220,000 for joint filers for next year. (The current range is between $150,000 and $160,000.} However, the phase-out range for single, head of household, and married filing separate status will remain at AGI of $95,000 to $110,000.

After all these favorable changes, Education IRAs are now prime-time education savings vehicles. Of course, the tax advantages multiply dramatically if you start contributing while your children are still quite young. In particular, you must start very early to gain any meaningful tax savings if you intend to use Education IRA withdrawals to cover K-12 expenses. Because of the increased contribution limit coming next year, you may want to go ahead and set up Education IRAs this year (even though the contribution limit is $500), just to get a head start on saving. (Remember, though, a contribution for 2001 must be made by the end of this year.)

Qualified Tuition Plans Are Now Terrific

Until now, so-called qualified state tuition programs (also called QSTPs and Section 529 plans) were pretty good deals.These state-sponsored arrangements delivered tax-deferral advantages until payouts were taken to cover eligible college costs; and earnings included in those payouts were taxed at the student's low rate, rather than at the presumably much higher rate applicable to the person who funded the account (typically the parent).

The new law makes these programs a great deal, rather than just a good one. Effective next year, they will be redesignated as "qualified tuition programs" (QTPs). More importantly, payouts to cover eligible higher education expenses will become tax-free. Obviously, tax-free is much better than tax-deferred. This change will apply equally to new and existing accounts. So, QTPs have suddenly become a terrific opportunity for parents who can afford to start college savings programs while their children are still fairly young. Simply put, the generous tax advantages mean much less need be taken out of your financial hide to fully provide for your children's future college costs.

Currently, most state-sponsored college savings account plans allow you to make lump-sum contributions of $100,000 or more. Typically, you are offered several investment alternatives, including selected equity mutual funds. If the account's investments outperform the rate of inflation for college costs, you come out that much ahead of the game. Also, most college savings account plans now welcome out-of-state investors and will cover expenses from any accredited college in the U.S. So, you can shop around to find the program you like best. (However, some plans offer significant state tax advantages for in-state residents.)

Under the new law, you will also be able to transfer money tax-free from one QTP account into another QTP account set up for the same beneficiary. So, if you decide another program is better than the one you're in, you can effectively make a tax-free rollover into the better program. Similarly, you can transfer money from one family member's QTP account tax-free into another family member's account within the same state-sponsored program or another state's program. Starting next year, "family members" will include first cousins of the account beneficiary.

Finally, beginning next year the new law permits private educational institutions to sponsor tax-free QTPs that offer prepaid tuition credits or certificates. Unlike state-sponsored QTPs, however, these private programs will not be allowed to offer the more flexible and attractive college savings account arrangements. For this reason, the state-sponsored programs will probably continue to be the preferred choice for most people. Also, the new rule allowing tax-free payouts from privately sponsored QTPs doesn't become effective until 2004 (even though the accounts can be opened beginning next year).

This is all great news, but perhaps the nicest thing about QTPs is they are available to all taxpayers, regardless of how high their income. That's not the case for most of the other breaks covered in this letter. Observation: A lot of taxpayers are going to have the option of contributing to either a QTP or an Education IRA (or both, even though with the latter the ability to contribute begins to phase out once adjusted gross income reaches $95,000 for singles or $190,000 on joint returns). So which should you choose?

As a result of the changes discussed earlier, they both offer the opportunity to accumulate earnings tax- free. However, beyond that, several differences exist. For example, if there's a chance your family might qualify for financial aid, a QTP looks more appealing because it counts as the donor's asset in the financial aid formula while an Education IRA is considered the student's asset. (Student assets count against you more heavily in the formula.) QTPs also have the advantage when it comes to funding because the annual limit on contributing to an Education IRA is still only $2,000 (beginning next year), but up to $50,000 can be stuffed gift-tax-free into a QTP in one year if you elect to spread that amount over a five-year period. Of course, Education lRAs have some advantages of their own. Tax-free distributions from such accounts can be used for schooling at the high school or lower level, while this won't work with a QTP. In addition, Education lRAs offer you more control over how contributed funds are invested, and the investment costs themselves can be lower than they would be in a QTP .Thus, like a lot of things in life, which (if either) of these education savings vehicles you select depends on your own unique circumstances.

New Deduction for College Expenditures

Why can't you just outright deduct college costs? Good question. In fact, you may be able to starting next year. A brand-new break will allow you to write off up to $3,000 of college tuition and fees for you, your spouse, or any person who can be claimed as a dependent on your tax return. This new deduction will be "above-the-line," meaning you need not itemize to benefit. However, the deduction will vaporize once your AGI exceeds $65,000 if you are single or $130,000 if you file a joint return. (There's no gradual phase- out here; you will either be 100% eligible or 100% ineligible.) In 2004 and 2005, the maximum deduction will increase to $4,000 and be subject to the same AGI limits. However, in those two years, singles with AGI between $65,000 and $80,000 will be entitled to a maximum $2,000 deduction, and so will joint filers with AGI between $130,000 and $160,000. That's the good news. Now for all the restrictions. First, you are completely ineligible for this write-off if you are married and file separately from your spouse.

• No deduction is allowed to any person who can be claimed as a dependent on another person's return.
• You cannot take tax-free Education IRA or tax-free QTP payouts for college expenses and then claim a deduction for those very same expenses. Similarly, you cannot claim the Hope Scholarship or Lifetime Learning tax credit for college expenses and then claim a deduction for the very same expenses.
• Finally, this new break will expire after 2005 unless Congress takes action to extend the deal.

More Liberal Rules for College Loan Interest Deduction

Under current law, you can deduct up to $2,500 of annual interest paid on loans to finance college expenses. However, the deduction is limited to the first 60 months interest is due even if the loan is for a longer term. Starting next year, the 60-month rule will be eliminated. In addition, the phase-out rule that reduces or eliminates deductions for higher-income taxpayers will be liberalized. Starting in 2002, the phase-out range will be between AGI of $50,000 and $65,000 for singles (up from the current range of $40,000 to $55,000) and between AGI of $100,000 and $130,000 for joint filers (up from $60,000 to $75,000). Bottom line: you are now more likely to qualify for this write-off.

Tax-Free Employer Education Reimbursements Made Permanent The rule allowing tax-free employer reimbursements for up to $5,250 of an employee's annual education expenses was scheduled to expire at the end of this year. The new law makes this break a permanent fixture in the Tax Code. Starting in 2002, you'll also be able to receive tax-free reimbursements for graduate courses. Until then, reimbursements for graduate courses don't qualify.

Ohio Allows a Deduction on the QTP The 529 Plan is even better when you factor in the Ohio deduction of up to $2,000 per person per year. Any excess can be carried over to future years until used up. We just received word from a high ranking state tax official that permits us to get a quicker deduction by setting up QTP's in the name of the parents and later transferring the monies for the children's education.

That's the full scoop on all the new education tax incentives. Hopefully, you'll be able to take advantage of one or several of these valuable benefits. In particular, you might want to start saving up your money right now if the new and improved Education IRA or the new and improved QTP accounts look attractive.

If you have questions about any of the provisions explained in this letter or any questions at all about the new tax law in general, please don't hesitate to call. We look forward to assisting you in planning to reap tax savings from all the good things the new law offers.

Very truly yours,

CPA Advisory Group, Inc.

THE INFORMATION CONTAINED IN THIS MESSAGE IS LEGALLY PRIVILEGED AND CONFIDENTIAL, INTENDED ONLY FOR THE USE OF THE INDIVIDUAL OR ENTITY NAMED ABOVE. IF THE READER OF THIS MESSAGE IS NOT THE INTENDED RECIPIENT, YOU ARE HEREBY NOTIFIED THAT ANY DISSEMINATION, DISTRIBUTION, OR COPY OF THIS EMAIL IS STRICTLY PROHIBITED.