North Carolina Society of Accountants

Economic Growth and Tax Relief Reconciliation Act of 2001

(EGTRRA)

Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 on May 26, 2001. This legislation, the largest tax cut since 1981, contains a reduction in individual income tax rates, which drops the top rate from 39.6% to 35%. The bill also repeals the estate tax, doubles the child tax credit, provides tax relief for married couples, expands education and retirement saving tax incentives and provides limited relief from the individual alternative minimum tax (AMT).

The bill contains some tax cuts which are retroactive to the start of 2001, including the creation of a new 10% tax bracket, resulting in the Treasury Department issuing tax refund checks this fall. Tax refund checks will range from $300 for single persons and $600 for married couples filing joint returns. The other rate reductions begin to take effect July 1, 2001, and will be implemented by revising the withholding tables for 2001.

The following is a brief description of the provisions included in the Economic Growth and Tax Relief Reconciliation Act of 2001 based on the bill and Summary prepared by the Staff of the Joint Committee on Taxation which can be found at www.house.gov/jct as referred to as HR 1836.

All rules effective for 2002 unless otherwise stated

Reduction of the 15% tax bracket to 10%. The Department of Treasury will be issuing checks equal to the amount of their 2001 tax savings from the new 10% rate bracket. The maximum credit will be $300 in the case of single individual, $500 in the case of a head of household, and $600 in the case of married couple filing a joint return.

Regular income tax rate reductions effective after June 30,2001

Phase-out of itemized deductions and phase-out of restrictions on personal exemptions will be effective beginning in 2006 and fully effective for taxable years beginning after Dec. 31, 2009.

Expansion of withholding tables - effective after June 30, 2001

Child tax credit will be increased to $1,000 - effective for taxable years beginning after Dec. 31, 2000 the phased in as follows:

Child tax credit is refundable to the extent of 10% of earned income over $10,000 in 2001 through 2004 and 15% of earned income over $10,000, beginning in 2005. Special refundability limits apply for families with three or more children. Refundable portion does not constitute income and shall not be treated as resources for purposes of determining eligibility or the amount or nature of benefits or assistance under any Federal program or any State or local program financed with federal funds.

Refundable child tax credit no longer will be reduced by the amount of the alternative minimum tax

Permanent extension of the adoption credit and exclusion from taxation for employer provided adoption assistance
Increase maximum credit and exclusion to $10,000 per child, including special needs children
Increase the phase-out range for the credit and exclusion to $150,000 - 190,000.

Increase the maximum amount eligible employment - related expenses from $2,400 to $3,000 for one individual (from $4,800 to $6,000 for two or more individuals)
Increase maximum credit to 35% of eligible expenses
Modify phase-down of the credit so that it begins at $15,000 of adjusted gross income

Taxpayers receive tax credit equal to 25% of qualified expenses for employee childcare and 10% of qualified expenses for childcare resource and referral services. The maximum total credit that may be claimed by a taxpayer cannot exceed $150,000 per taxable year.

Standard deduction increases to twice the amount for singles and increases the size of the 15% income bracket to an amount that was equal to twice that of single filers. These provisions would begin to phase in beginning in 2005.

This section also provides:

Simplification relating to earned income credit providing an increase in the income phase out range for married filing joint returns by $3,000, phased in over seven years
Excludes nontaxable employee compensation from the definition of earned income
Simplified definition of a child for purposes of earned income credit
Simplification of the calculation of earned income credit by replacing modified adjusted gross income with adjusted gross income, beginning in 2002.
Beginning in 2004, legislation will allow IRS to use the math error procedure to deny the EITC if the Federal Case Registry database indicates the taxpayer is the non-custodial parent.

Education IRA modifications

Annual contribution limit increased to $2,000
Allow tax free withdrawals for K-12 (elementary and secondary schools) expenses, including purchase of computer technology or equipment for internet access and related services
Phase out range increased to $190,000 to $220,000 for married taxpayers filing joint return (double the range for single taxpayers)
Corporations and other entities (including tax-exempt organizations) are permitted to make contributions to Education IRAs
Deadline for contribution is changed to April 15 of following year (without extension) similar to Traditional IRA contribution deadline
Allow the use of HOPE credit or Lifetime Learning credit in the same tax year as a distribution from an Education IRA as long as the distribution is not used for the same educational expenses for which a credit was claimed
Repeal excise tax for contributions to an education IRA when a contribution is also made to a qualified tuition plan for the same beneficiary
Clarification that various age limitations do not apply to special needs beneficiaries. Allow contributions for special needs beneficiaries above the age of 18. Eliminate a deemed distribution at age 30 for special needs beneficiaries

Private Prepaid Tuition Programs

Tax free distributions from state plans (529 plans)
Allow private prepaid tuition plans
Allow tax free rollovers for the benefit of the same beneficiary
Expand definition of family member to include first cousins
Allow the use of HOPE credit or Lifetime Learning credit in the same tax year as a distribution from an Education IRA as long as the distribution is not used for the same educational expenses for which a credit was claimed
Allow tax free distributions for enrollment or attendance costs of a special needs beneficiary
Impose an additional10% tax on distributions that are includible in income.

Employer Provided Educational Assistance

Income exclusion for employer-provided education assistance to graduate education
Make permanent the exclusion for both undergraduate and graduate education

Student Loan interest deduction

Increases income phase-out ranges for eligibility for student loan interest deduction to $50,000 to $65,000 for single taxpayers and to $100,000 to $130,000 for married taxpayers filing joint returns. These limits will be indexed for inflation.
Repeals limit on the number of months (was 60 months) during which interest paid on a qualified education loan is deductible and the restriction that voluntary payments of interest are not deductible.

Eliminate tax on National Health Services Corp (NHSC) and the Armed Forces health scholarship awards. Does not apply to amounts received by students for regular living expenses, including room and board.

Deduction for qualified Higher Education Expenses - "Above the line" deduction for qualified higher education expenses as defined for purposes of the HOPE credit as follows:

Phase-0ut and Repeal of Estate and Generation-Skipping Transfer Taxes (GST); Increase in Gift Tax Unified Credit

*Sunset provision becomes effective; expect legislative changes prior to 2010.

Credit for State death (estate) taxes phased out

Effective in 2005, the State death tax credit is repealed; after which, there is a deduction for death taxes actually paid with respect to property included in the gross estate of the decedent.

Limited Basis Adjustment - no step-up on property transferred at death after Dec. 31, 2009 in excess of amounts given below. Property acquired after Dec. 31, 2009 subject to certain limits will be the LESSER of:

(a) Adjusted basis of the decedent
(b) FMV of property on the date of decedent's death

Limited Step-Up On Basis
(a) $1,300,000 aggregate to heirs (non-spousal)
(b) $3,000,000 additional assets to a surviving spouse
(c) $4,300,000 total to a surviving spouse

The $1,300,000 and $3,000,000 amounts are adjusted annually for inflation and rounded down to the nearest multiple of $100,000 and $250,000 respectively.

Generation-Skipping Transfer Tax (GST) Rules - simplification provisions are effective 2001

Deemed allocation of the GST exemption to lifetime transfers to trusts that are not direct skips
Retroactive allocation of GST exemption for unnatural orders of death

Additional reporting requirements for large gifts over $25,000 and estate bequests over $1.3 million.
Retain estate tax recapture provisions for certain estate tax benefits extending past the date of repeal
Treat transfers at death by US persons to nonresidents who are not US citizens as a sale or exchange (effective for transfers after 2009)
Limit gain or loss recognition on the transfer of property in satisfaction of a pecuniary bequest
Clarify that no gain is recognized at death on transfers of property subject to a liability
Extend the income tax exclusion for gain on the sale of a principal residence to estates and heirs
Impose restrictions on split-interest trusts
Expand the estate tax rule for conservation easements - effective in 2001
Waive the statute of limitations for refunds of estate tax recapture under special evaluation rules for farm and other real property (effective for claims filed within one year of date of enactment)
Qualified Family Owned Business Exemption repealed after Dec. 31, 2003. (Becomes superceded by the then scheduled Estate and GST tax exemption.)
Installment Payment Relief - effective for decedents dying in 2002
Estate Tax Recapture from Cash Rents of Specially-Valued Property effective for refund claims filed prior to the date that is one year after the date of enactment

Increased contribution limits phased in starting in 2002 as follows:

Other plan contribution factors:

Elective deferrals not included in qualified plan deduction limits.
Compensation definition for qualified plan deduction rules include elective deferrals under 401(k), 403(b) and 457 plans and salary reduction contributions under cafeteria plan.
Maximum Exclusion Allowance repealed. Calculation is adjusted for 2001 for situations where a 403(b) plan is maintained along with a Defined Benefit plan.
IRA contributions made to retirement plans - effective in 2003. Qualified defined contribution plans, 403(b) plans and governmental 457(b) plans may permit participants to make IRA contributions to a separate account maintained under the employer's retirement plan.
Eliminated coordination of 457 salary deferral limitation with other salary deferral plans (ie 401(k), 403(b), SARSEP and SIMPLE IRA deferrals).

Additional "catch up" contributions for individuals age 50 and over phased in starting in 2002 as follows:

Non-refundable tax credit up to 50% of the first $2,000 of salary deferral contributed to an IRA, 401(k), 403(b) or 457 plan. Effective for tax years 2002-2006 as follows:

Contributions to eligible retirement savings plans would continue to be deductible or excludable from income as under current law. If a potential credit recipient (or such person's spouse) receives a pre-retirement distribution in any year, the ability to receive a government match in that year or in the two subsequent years will be reduced by the amount of the distribution.

Tax Credit for start-up costs for qualified plan, SEP or SIMPLE. Credit would apply to 50% of the first $1,000 in administration and retirement-education expenses for three years after establishing a new employment-based retirement plan and would be available to employers with 100 or fewer employees. No deduction would be allowed for the amount claimed as a credit.

Portability

Rollovers allowed among 457, 403(b) and qualified plans.
Allow rollover of after-tax contributions to IRAs and other retirement plans.
Rollover of contributory IRAs qualified retirement plan, 403(b), 457(b).
Rollover of deceased spouse's qualified plan distributions to surviving spouse's employer sponsored qualified plan, 403(b) annuity or governmental 457 plan in which the surviving spouse participates.
Treasury granted authority to waive 60-day rollover rule for reasonable circumstances including: "casualty, disaster, or other events beyond the reasonable control of the individual subject to such requirement."
Automatic transfer to IRA of distributions less than $5,000. Provision impacts distribution of involuntary cash-outs of vested accrued benefits in excess of $1,000 unless the participant directs otherwise. The Department of Labor is directed to issue safe harbor language with respect to the designation of an institution and investment of funds. This provision is not effective until final DOL regulations are published, and such regulations must be finalized not later than three years after the date of enactment.
State and local government employees can direct transfer from 403(b) annuity or 457 plan to a governmental pension plan to purchase permissive service credits or to repay certain refunds from the plan.

Miscellaneous Retirement Provisions

Plan loans permitted for partners, sole proprietors and S-corporation owners.
Roth 401(k) and 403(b) plans - Effective in 2006, elective deferrals to 401(k) or 403(b) plans can be treated as after-tax Roth contributions.
QDRO distributions from 457 plan eligible for rollover by former spouse.
"Same desk rule" eliminated by replacing "separation from service" in section 401(k)(2)(B) with "severance from employment." Conforming changes would be made for 403(b) arrangements and 457(b) plans.
Eliminate IRS user fees for determination letter requests - applies to small employer with less than 100 employees with at least one non-highly compensated employee. Waiver does not apply to plans older than 5 years or prototype which the sponsor intends to market to participating employers.
Hardship Distribution salary deferral waiting period reduced from 12 months to 6 months. Applies when re-initiating salary deferrals after a hardship distribution was taken. All hardship withdrawals will be considered ineligible for rollover, therefore, not subject to 20% mandatory withholding rules or early withdrawal penalty.
No tax on employer-provided qualified retirement planning service when provided as a non-discriminatory employee benefit.
Defined Benefit actuarial reduction required only for benefit commencement prior to age 62 (changed from Social Security normal retirement age). Commercial Airline pilots have special consideration for age 60 - 62.
Matching contributions will be required to use top-heavy vesting schedules, effectively eliminating five year cliff vesting and 7 year graded vesting (special phase-ins for union plans)
Matching contributions (including Safe Harbor) will satisfy the top-heavy requirement.
Family aggregation rules modified for purposes of determining key employees, however, such aggregation rules will continue to apply for purposes of determining whether an individual is a 5% owner.
Amounts deferred under governmental 457 plans are taxable when paid (and not when made available)
Repeal of multiemployer funding limit applicable to defined benefit plans effective after 2004. The full funding limit would be 165% of current liability for plan years beginning in 2002, 170% in 2003 and repealed in 2004.
ESOP dividends may be reinvested without loss of dividend deductions. The employer would be allowed to deduct dividends paid to an ESOP when its employees are allowed to elect to take the dividends in cash or leave them in the plan for reinvestment in employer stock. Expanded Secretary of Treasury's authority to disallow dividend deduction for avoidance or evasion of tax and also for payment of unreasonable dividends.
Waiver of tax on non-deductible SIMPLE plan contributions for household workers.
Retroactively allow 403(b) salary deferrals to be excluded from 401(k) plan coverage testing for certain employees of tax-exempt charitable organizations.
Provide limited retroactive relief from 1997 Act rule limiting investment of employee contributions to 401(k) plans in employer securities or real property.
Extend special rule allowing deduction for unfunded termination liability to most terminating defined benefit plans.
Additional disclosure required for significant reduction in Benefit Accruals impacts defined benefit plan, money purchase pension plan and cash balance plans. Effective for plan amendments that take effect after the date of enactment, although transitional relief is provided. Regulations are required within 90 days of enactment. A study of cash balance conversions is required within 60 days after the date of enactment. Notice would be required to describe the benefit reduction caused by the plan amendment and be provided within a reasonable time period prior to the effective date of the plan amendment. Failure to comply with the notice requirements would be $100 per day per omitted party with a maximum penalty of $500,000 in any year. The Secretary of the Treasury could waive this penalty if reasonable cause for failure is shown.

Increase the individual alternative minimum tax exemption amount by $2,000 for single taxpayers and $4,000 for married taxpayers filing joint returns for 2001 through 2004

Corporate estimated tax payments due on September 15, 2001 are delayed until October 1, 2001 and portion of corporate estimated tax payments due on September 15, 2004 are delayed until October 1, 2004.

Extend tax-related deadlines up to 120 days (was 90 days) for taxpayers determined to be affected by Presidentially declared disaster. Effective upon enactment.

Income tax treatment of certain restitution payments to Holocaust victims effective for amounts received after 1999. Restitution payments made to an eligible individual (or the individual's heirs or estate) are excluded from gross income and not taken into account for any provision of the Code that takes into account excludable gross income in computing adjusted gross income (e.g., taxation of Social Security benefits).

All provisions of the bill do not apply for taxable, plan or limitation years beginning after Dec. 31, 2010.

Items, which did not get enacted:

Proposed provision allowing tax-free rollovers from IRAs to charities
Proposed provision reducing the 50% penalty for failing to take a required minimum distribution and provision to change post-death required minimum distributions

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