Planning Opportunities Await under the Tax Relief Act

2002 is going to be a pivotal year for taxpayers. Many of the key changes made by the Tax Relief Act of 2001, as well as changes made by earlier tax laws, go into effect for the first time in 2002. The following summary is designed to help you keep track of the most important new-for-2002 tax changes.

Liberalized Estate and Gift Tax Rules. The new law provides a major benefit by decreasing the maximum gift and estate tax rate and increasing the $675,000 estate tax exemption to $1 million for 2002 and 2003. The exemption is scheduled to increase to $1.5 million for 2004 and 2005, $2 million for 2006 through 2008, and $3.5 million in 2009. The estate tax is scheduled to disappear, at least for one year, in 2010. However, under what is called a "sunset rule", it will reappear in full force and with only a $1 million exemption in the year 2011, unless the tax law is changed again prior to that date.

The gift tax exemption also increased to $1 million in 2002, but will remain at that amount permanently. In addition, taxpayers continue to have the right to make tax-free gifts of $11,000 per year per donee (a combined $22,000 for married couples), a slight increase from earlier years.

Under the current law, capital gains disappear at death and the heirs receive a new tax basis for inherited assets which usually is equal to their date of death value. If the estate tax were to be repealed in 2010, the trade-off is that capital gains will no longer disappear at death. Accordingly, you should retain all records of cost for your various assets and make a list of the "cost basis" of all your major assets. For purchased items, keep receipts and statements showing the amount you paid. For items inherited before 2010, basis ordinarily is the date of death value of the item. For property acquired by gift, your basis usually is the same as the donor's. For depreciable property, basis is reduced to reflect allowable depreciation.

As the new federal law gradually eliminates the federal estate tax, it also eliminates the portion of the federal tax which Illinois automatically receives. Accordingly, Illinois will almost certainly consider replacing the lost revenue from the present estate tax by adopting is own Inheritance Tax, as Wisconsin has just done.

Because of the sluggish economy and disappearing budget surplus, it is highly likely that the total repeal of the estate tax will be reconsidered prior to 2010. In the meantime, as a result of these changes, you should review your current estate plan documents to take full advantage of the various tax savings opportunities provided by the new tax law before Congress reconsiders some of its more beneficial provisions.

Liberalized Rules For Required Distributions from IRAs and Qualified Plans. New regulations lengthen the period over which you are required to take distributions from IRA's and qualified retirement plans. As a result, after you retire, you will be able to maintain larger IRA balances growing on a tax-deferred basis over a longer period of time. This is a major tax benefit, particularly if you intend a portion of your IRA to pass to your children upon the death of you and your spouse.

Qualified Tuition Programs. Qualified tuition programs (also called "Section 529 Programs") generally allow taxpayers to buy tuition credits for their children or make contributions to an account set up to meet college expenses. Distributions from state-sponsored qualified tuition programs are tax-free if used for college tuition. The portion of benefits not used for qualified education expenses trigger income tax and a 10% penalty. The significant advantage of Section 529 plans is that such plans have neither limited contribution levels nor income eligibility restrictions for investment.

Education Savings Accounts. Coverdell education savings accounts (formerly known as Education IRAs) are also more powerful tools under the new law. The annual contribution limit for such accounts is now $2,000, up from $500 for 2001. These accounts may now be used for a wide array of education expenses, such as elementary and secondary public, private, or religious school tuition and expenses, extended day programs, and computer purchases. Last year, the accounts could only be used for college related expenses.

New Deduction For Higher-Education Expenses. Eligible taxpayers may now claim a deduction for higher education expenses. This deduction is available whether or not the taxpayer itemizes or claims the standard deduction. It's an up-to-$3,000 deduction for qualifying joint filers whose income does not exceed $130,000 and for qualifying singles or heads of households whose income doesn't exceed $65,000.

Retirement Savings Accounts. Now is a good time to consider making contributions to an IRA. Qualifying contributions for 2001 can be made until April 15, 2002. Over time, IRAs have proliferated - there's the regular IRA, which may be funded with deductible and/or nondeductible contributions, the Roth IRA, SEP-IRA, and SIMPLE IRA. What do all these IRAs have in common? They can help you and your family save significant amounts for retirement or a child's education on a tax-favored basis.

For 2002, the maximum annual contribution to an IRA or a Roth IRA is $3,000 (its was $2,000 for 2001), and a taxpayer age 50 or older can make an additional catch-up contribution of $500. If you file jointly with your spouse, you can make an annual contribution to a Roth IRA if your income doesn't exceed $150,000 to $160,000 ($95,000 to $110,000 for single taxpayers). Roth IRA contributions aren't deductible. However, earnings are tax-deferred within the Roth IRA and (unlike a traditional IRA) are tax-free if paid out after you reach age 59 1/2, or upon death or disability, or (up to $10,000 lifetime) for first-time home buyer expenses of you, your spouse, child, or grandchild. You can make Roth IRA contributions even after you attain age 70 1/2 if you have sufficient earned income and you do not have to take minimum distributions from a Roth IRA after you attain that age. Roth IRAs are an excellent wealth-building vehicle for your family. In addition, you may want to consider funding a Roth IRA for a child or grandchild, if he or she has sufficient earned income so as to qualify.

Since many of the strategies can be difficult to navigate, please remember your advisors at WilliamsMcCarthy LLP are here to assist you as you consider these various opportunities that have been made possible under the new tax law.