Hugh's comments on the just passed tax cut

Actually this document was from 2001!! The 2003 tax cut is here

The Quicken.com estimator has just been updated for the changes in the tax cut:

http://www.quicken.com/taxes/taxrelief/estimator/

The amazing thing about the final $1.35 trillion tax relief bill (the Economic Growth and Tax Relief Reconciliation Act of 2001, what a name!) is that much of it actually sounds reasonable! It not only gives an immediate quick payback to all current taxpayers, but it also provides delayed, long term relief to the tax payers providing the largest burden of taxation, the over $200K/year crowd. The quick payout to the masses last summer helped stimulate the economy a little (well, at least it helped discounters like Wal-Mart), and once the economy revives, the high income crowd will eventually get the tax relief they deserve since they are paying most of the taxes anyway. But there is a huge catch as there always it. Plus now that we are in recession one must wonder how much revenue this will remove from the federal budget where the surpluses have magically disappeared.

Some of the new highlights and what they really mean

  • A new 10% tax bracket - This is the new quick fix that helps everybody to some degree. The first $6,000 earned ($12,000 for couples) is now taxed at 10%, not 15%. Since this is the first bracket for everybody, everyone saves. Notice that this also is true for minors over 14. Now their first $6,000 earned is taxed at only 10%, so this actually helps all parents with working children or children with investment income.

    The immediate impact here is that most taxpayers received a $300-$600 check last summer. To some people this was money they definitely needed, but to many middle-class and upper-class households it was less than their monthly housing payment. So they either just spend it or saved it. But now that it has passed it didn't really seem to help the economy or the 2001 holiday sales much, except for the discounters like Wal-Mart and Target, and consumer electronics retailers like Best Buy.

  • Other lower brackets - but over time - The top 39.6% bracket drops to 35% (not 33% as in the Bush's original proposal), and it is not fully in effect until 2006. Similarly the 36% bracket drops to 33%, 31% to 26% and the large 28% bracket falls to 25%. So the more you make the more you still have to pay in taxes, but not as much as before. Plus you will have to wait a few years before you get your tax relief in full. This delayed phase in will help to make sure the surpluses really continue 5 years from now which is definitely far from an economic certainty.

  • Removal of marriage penalty - The standard deduction of married dual income households will be increased substantially to reduce the effects of the "marriage penalty". It is about time!

  • Increase child tax creditIncreased from the paltry $500 to a still paltry $600 in 2001 up to $1,000 in 2010. It is still paltry but does recognize that parenting children is in the country's best interest and costs a tremendous amount!

  • Increased contribution limits for 401(k) and IRA plans. The 401(k) limits will be increased from $10,500 to $15,000 and IRA limits from $2,000 to $5,000, gradually through 2008. This will primarily help more affluent people but gives all people the idea that if you have more money you can invest it in tax preferred accounts above the current limits. The IRA limit has been $2,000 for a long time and its increase was definitely overdue.

  • Changes in Education Savings Vehicles The pitiful limit on Education IRA contributions has now been raised from $500 to $2,000 which would be great except something even better happened too. The new bill now makes state 529 plans exempt from federal income tax on withdrawal. These plans typically have of contributions in one year ($50,000 for singles or $100,000 for couples). And now these are federal tax free just like the Education IRA. Since most states also have their own plans state tax free, the 529 plans are now essentially tax free. So the only advantage of an Education IRA over a 529 plan is more flexibility in choosing investments.

  • Estate Tax ChangesThe estate tax goes away in 2010, and for 2002 the unified credit jumps immediately from $675,000 to $1 million. Remember in the 1997 Taxpayer's Relief Act it was scheduled to increase to $1 million in 2006, but oh so slowly. The new bill increases the credit to $2 million in 2006, $3.5 million in 2009 and phases it out completely in 2010. I don't know if a complete phase out was really necessary, but the unified credit should have at least been increased as quickly as inflation. But then again it really isn't phased out forever anyway as you read on...

    But now for the most amazing part of all... the CATCH

    I don't know how many people understand this, but this lengthy and detailed tax cut bill, all this legislation, all this work by our representatives in Washington....

    It all goes away in 2011 !!!!!

    For instance, if your billionaire uncle dies in 2010 he can pass on his estate completely tax free that year, but if he dies in 2011, the estate tax comes back and he pays millions. Another craziness in the estate tax law is that in 2010 when the estate tax is lifted the step-up in basis is removed. So if your millionaire uncle with $3.0 million in stock dies in 2009 you get all $3.0M, but if he dies in 2010 and he only paid $1.0M for the stock, you get to pay capital gains tax on $2.0M when you sell it! So although there is no estate tax, now capital gains tax rears its ugly head on your inheritance! And if the rich uncle has lousy records on what prices he boughtor received the stock, someone has to figure it all out to figure out the cost basis. What a fiasco!

    Then all the other cuts and special provisions made by this bill, many of which are not fully phased in until 2005 or 2006 all go away in 2011. Of course, this gives Congress several years to make things permanent if they feel this is necessary. So although many people will be griping about the lousy $300 to $600 rebate they will be seeing this year, that might be $300 to $600 you won't be keeping come 2011 anyway!

    Hugh
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