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Editor's Note: Because of the importance to all professionals of the planning changes in RELIEF Act 2001, GiftLaw is publishing this Special Report on the largest tax cut in the past two decades.

RELIEF Act 2001
The Joint Committee on Taxation (JCT) report on the proposed provisions of the RELIEF Act 2001 (Restore Earnings To Lift Individuals and Empower Families) Act has been released. Senate negotiators, led by Republican Sen. Charles Grassley (R-IA) and Democratic Sen. Max Baucus (D-MT), have announced a compromise plan that reaches the Congressional Conference budget targets. The RELIEF Act is scheduled to include $1.25 trillion in tax relief over ten years plus $100 billion in stimulus for 2001. Markup for the bill is scheduled in the Senate Finance Committee for May 15, 2001.

The RELIEF Act 2001 includes seven major sections. These sections cover the income tax brackets, the child tax credit, marriage penalty relief, education incentives, estate tax repeal, pension and retirement enhancements, and the alternative minimum tax.

I. Tax Bracket Reductions

The heart of President Bush's tax plan is reduction of all income tax brackets. These brackets will be reduced from the existing 15%, 28%, 31%, 36% and 39.6% brackets to lower levels. The 15% bracket will be reduced to 10%, retroactive to January 1, 2001. This change will absorb most of the $100 billion dollars allocated for immediate stimulus. Treasury has authority to promulgate revised withholding tables to enable taxpayers to benefit now from the new 10% bracket.

The schedule of bracket reductions under RELIEF Act 2001 is as follows:

Old Rate	2002 Rate	2005 Rate	2007 Rate
15%	10%	10%	10%
15%	15%	15%	15%
28%	27%	26%	25%
31%	30%	29%	28%
36%	35%	34%	33%
39.6%	38.6%	37.6%	36%

Immediate lowering of the 15% bracket to 10% produces an immediate tax reduction for all taxpayers. However, the lower bracket would not apply to all of the current 15% bracket. The 10% bracket applies to $6,000 of income for single persons, $10,000 for heads of the households, and $12,000 for married couples filing jointly. In effect, the 15% bracket has been split into a 10% and a 15% bracket. Note also that phase-in of the new brackets over several years will reduce the cost of the lower brackets.

Other major changes that impact tax payments include a significant increase in the point at which itemized deductions begin to be phased out. The 3% reduction on itemized deductions would not be applicable in 2009 until a married couple with a joint return has income of $245,500. In addition, the personal exemption phase-out would be repealed entirely in 2009.

II. Child Tax Credit

Dependent children under the age of 17 currently qualify for a $500 tax credit. This child credit amount would be increased retroactively to $600, effective January 1, 2001. It would be increased to $700 in 2004, $800 in 2007, $900 in 2010 and $1,000 in 2011. In addition, in a compromise demanded by Democrats on Senate Finance, a low-income family may receive a credit up to 15% of earned income over $10,000. Thus, families with several children and incomes of $10,000-$30,000 could actually receive a refund from their excess child tax credits.

III. Marriage Penalty Relief

Under current law, couples with relatively equal incomes could pay more tax than they would if they were both single persons. To minimize this problem, the RELIEF Act 2001 both doubles the standard deduction for married couples and increases the 15% bracket to equal double the 15% bracket for single persons. However, the phase-in does not start until 2006 and is not completed until 2010. This provision is obviously phased-in relatively far into the future in order to save or reduce the cost of marriage penalty relief. An added benefit for low-income married couples is that the phase-out for the earned income tax credit will be raised by $3,000 in 2002.

IV. Education Incentives

During the past eight years, there has been an exponential growth of complex education incentives. This tax bill modifies and enhances most of those incentives.

Under current law, an education IRA may be funded with cash in the amount of $500 per beneficiary under age 18 each year. The amounts grow tax-free and may be withdrawn tax-free by the beneficiary for "qualified higher education expenses." These expenses include tuition, books and limited room and board. Distributions must be made within 30 days after age 30, but the account may be rolled over into an education IRA for another family member.

The new bill will change the name of the education IRA to "Coverdell Education Savings Accounts." The permissible contribution will be increased to $2,000 per year and the phase-out range for married taxpayers will be increased to $190,000 - $220,000 of modified AGI. "Qualified educational expenses" will now also include expenditures for elementary and secondary education.

Section 529 plans are referred to as "qualified state tuition programs" and allow a person to deposit cash for the higher education expenses of a designated beneficiary. These amounts then grow tax-free and, if used for qualified educational benefits, may be distributed and expended for that purpose by the beneficiary with reduced payment of tax.

In a dramatic expansion of this plan, any eligible education institution, including a private school, may create its own qualified Section 529 Plan. Furthermore, in a manner similar to Coverdell Education Savings Accounts, expenditures for qualified expenses will not be taxable to the students. This dramatic expansion will permit nearly all educational institutions to allow grandparents and parents to "pre-fund" tuition and other qualified educational expenses.

A third provision of the education program would be to extend the Section 127 provision for employer-provided educational assistance of $5,250. Finally, the phase-outs for deductions of student loan interest would be expanded and there would be greater flexibility in issuance of bonds by non-profits.

V. Estate Tax Repeal

One of the more contentious issues in the Senate Finance Committee discussions was repeal of the estate tax. There remains strong support among both the Republican members of the House and Senate and the administration for a full repeal of the estate tax. However, the proposed methods for repeal present obvious tax planning problems. Thus the proposed RELIEF Act 2001 language attempts to include preferred provisions from both the Democratic and Republican plans. Predictably, the results are quite complex.

Under existing law, there is a $10,000 annual gift exclusion per donor-per donee, and an exemption from gift or estate taxes of $675,000 in 2001, $700,000 in 2002 and 2003, $850,000 in 2004, $950,000 in 2005 and $1,000,000 in 2006 and thereafter. There also is a 5% surtax on taxable estates between $10,000,000 and $17,184,000.

Deductions are permitted for marital and charitable transfers, for costs and debts and other items. Transfers at death provide the recipient with a "stepped-up basis" to fair market value for capital assets. There are provisions for special-use valuation of farms and ranches. There is also a specific gift exclusion for non-resident citizens.

Under RELIEF Act 2001, nearly all of those provisions would change dramatically. By 2011, the estate tax would be fully repealed. The exemption equivalent is expanded from $1 million to $4 million over that time. The top rate is reduced to 50% in 2002, and then lowered to 45% by the year 2007. After 2010, there will be no estate tax, but a 40% gift tax will continue to be applicable.

The estate exemption and top tax rate would be as follows:

Year	Exemption	Highest Estate Tax Rate
2002	$1 million	50%
2003	$1 million	49%
2004	$2 million	48%
2005	$3 million	47%
2006	$3 million	46%
2007	$3 million	45%
2008	$3.5 million	45%
2009	$3.5 million	45%
2010	$4 million	45%
2011	Estate tax repealed	40% (Gift tax only)

The retention of the 40% gift tax rate is for the purpose of discouraging transfers to lower income beneficiaries to minimize capital gains taxes. Several commentators have suggested that some very creative new tax shelters might be created in order to avoid capital gains tax if estate taxes were repealed. This provision is designed to minimize what Treasury views as excessively-creative planning.

After 2011, estate and generation-skipping taxes are fully repealed. There is then a modified carryover basis plan. Under the modified plan, an estate is permitted to have an asset base of $1.3 million that will be stepped up to fair market value. The $1.3 million is potentially increased by net operating losses and unused capital losses. Furthermore, transfers to a spouse will entitle the spouse to an additional stepped-up basis of $3 million. The basis step-up will be allocable to specific assets within the estate.

The basis step up exclusions include property acquired within 3 years of death. Property that is income in respect of decedent, stock of a personal holding company, stock of a domestic international sales corporation or foreign investment company will also not receive a step-up in basis. To assist the Service in tracking the basis of assets, there are extensive reporting requirements for estate executors. Executors who fail to report potentially could be subject to a $10,000 penalty. (Editor's Note: Sen. Grassley's explanation of the tax bill indicates that there will be a "full step up in basis" for assets in estates. The final bill could change substantially the JCT explanation.)

Several changes impact special business exemptions. In 2004, the qualified family-owned business deduction would be repealed. However, the 10-year recapture period for special use valuation could apply even after repeal of the estate tax until the expiration of the 10-year period. Installment payment rules for estate taxes would be retained.

Under current law, an estate may exclude 40% of the value of land subject to a qualified conservation easement with a maximum exclusion of $500,000 in 2002. RELIEF Act 2001 would allow qualified conservation easements to apply to any property in the United States that meets applicable requirements. The previous requirements for a specific geographic location were deemed too complex.

Generation skipping tax is generally applicable when there is a direct skip, a taxable termination or taxable distribution. The exemption of $1,060,000 (in 2001 and indexed thereafter) is available to reduce or eliminate generation skipping tax. RELIEF Act 2001 would simplify generation skipping transfer tax rules by automatically allocating GST exemption to any trust created during life that is an "indirect skip." Another helpful provision in the GSTT section would be an allowance for a "qualified severance" of a trust into an exempt trust and a non-exempt trust subject to GSTT. A further proposal is to allow a "substantial compliance" exception that could enable Treasury to permit potential reallocations of GSTT in order to produce the lowest possible inclusion ratio.

VI. Pension and Retirement Provisions

Under current law, an individual with earned income may transfer $2000 into a tax-deductible IRA or a non-deductible IRA, commonly referred to as a Roth IRA. The option to transfer up to $2000 exists if the individual has compensation in excess of that amount, he or she is not a participant in a company plan or he or she is below a specific phase-out level of adjusted gross income. With deductible IRAs, withdrawals are taxed as ordinary income.

In addition, withdrawals from tax-deductible IRAs prior to 59 ½ are subject to an additional 10% early withdrawal penalty, with exceptions for disabilities, certain periodic payments, medical expenses over 7 ½% of AGI, health insurance, education expenses or first-time home buyers expenses up to $10,000. Since the Roth IRA is funded with after-tax cash contributions, the contributions grow tax-free and may be withdrawn without tax. However, the 10% penalty tax on early withdrawals may apply unless a distribution is made 5 years after the creation of the Roth, after the age of 59 ½, due to death or disability, or for first-time home buyers up to $10,000.

RELIEF Act 2001 expands contribution amounts and also creates a new category for individuals age 50 and above. Increased IRA Contributions under the following schedule:

Year	Regular Contributions	50+ Contribution
2001	$2,000	$2,000
2002	$2,500	$3,000
2003	$2,500	$3,000
2004	$2,500	$3,000
2005	$2,500	$3,000
2006	$3,000	$4,000
2007	$3,000	$4,000
2008	$3,500	$4,500
2009	$3,500	$4,500
2010	$4,000	$5,500
2011	$5,000	$7,000
2012	(Amount Plus $500 Increase per year)

The contribution limits are also generally increased for many other types of plans. For example, limits under 401(K), 403(B) and 457 plans will be increased to allow contributions annually up to $15,000 when the phase-in is completed. The $170,000 compensation limits for plans will be increased under cost of living provisions.

IRA Charitable Rollover in 2010

In a provision very beneficial for facilitating charitable giving, RELIEF Act 2001 will allow distributions to qualified charities from an IRA. The distributions by persons age 70 ½ and older may be made outright to a charity, to a charitable remainder annuity trust or unitrust, to a pooled income fund or to a gift annuity. The "IRA to deferred gifts" option permits distribution to plans for the life of the IRA owner or for the lives of the IRA owner and his or her spouse.

Since the regular IRA is untaxed ordinary income and a Roth IRA may be withdrawn without income tax, this IRA rollover option will be used by persons with regular IRAs. Therefore, the IRA ordinary income element will be tier-one ordinary income for a charitable remainder annuity trust or unitrust. In addition, gift annuity payouts will also be ordinary income.

Finally, with transfer of an ordinary income asset, under Sec. 170(e) there will be no charitable income tax deduction. This rule applies both to gifts from IRAs outright to a charitable organization or into one of the life-income plans. However, the charitable distribution would not be subject to the regular 50% deduction limits. Since many donors now hold very large IRAs and under the new 2001 IRA distribution rules these balances will grow dramatically, there still will be great benefit to charities with the new rollover rules.

While the inclusion of the IRA to charity and IRA to CRT rollover is very favorable to charities, it is important to note that the rollover is not permitted until 2010 and thereafter. Obviously, the cost of making the rollover provision effective in an earlier year was not possible under the $1.35 trillion limit for RELIEF Act 2001.

VII. Alternative Minimum Tax

A separate tax structure exists to require individuals to pay minimum levels of tax, even if they have very large deductions due to accelerated depreciation, depletion and other tax purposes. An individual pays tax of 26% on the first $175,000 of AMTI and 28% on the excess. There is an exclusion of $45,000 for married persons, $33,750 for single persons and $22,500 for married persons filing separately, estates or trusts. The exemption amounts are phased out by 25% of the amount in excess of $150,000 for married couples, $112,500 for single persons and $75,000 for married persons filing separately.

A major concern expressed by many CPAs is that with the rate reductions and with the RELIEF Act, there will be a dramatic increase in the numbers of persons required to pay alternative minimum tax. In order to minimize that impact there will be an increase in the exemption of $4,000(JCT explanation) or $6,000(Sen. Grassley's explanation) for married couples or $2,000(JCT explanation) or $3,000(Sen. Grassley's explanation) for single persons.



Copyright (c) 2001 By A. Charles Schultz