Slow-Motion Tax Cut - provisions and procedures under new tax law

Kiplinger's Personal Finance Magazine, August, 2001 by Kevin McCormally

TAXES | The latest law is filled with plenty of goodies--and some mighty MEAN SURPRISES.

HOWARD Baker, the former Tennessee senator, marched into the history books 28 years ago by making a mantra out of a two-part question he tenaciously repeated during the Watergate investigation: What did the president know, and when did he know it? Americans sizing up the new tax law have a similar query: What do I get, and when do I get it? Knowing the answers is the starting point for taking advantage of the new rules.

The $1.35-trillion tax cut will dish out major helpings of both benefits and disappointments over the next decade. Delayed starts and long phase-in periods for many breaks demand patience aplenty. And a "sunset" provision that pulls the plug on all the goodies in 2011 seems like a cruel joke. But some of the new rules--particularly, juicy breaks for those Who save for college and retirement--offer incredible opportunities.

Yes, the much-maligned estate tax will be put out of our misery. But as things stand now, only those who die in 2010 are spared. The estates of those who leave this world in 2009 will face a top tax rate of 45%, which has prompted morbid jokes about life-support systems; in 2011, when the tax comes back from the grave, the top rate will be resurrected at 55%.

The check is in the mail

THE FIRST WAVE of nearly 100 million tax-rebate checks will begin arriving in mailboxes around the country in late July. This first fruit of the new law is an advance payment on the creation of a 10% tax bracket, retroactive to January 1. Congress decided to give taxpayers the first full year's benefit right away.

You should already have received a letter from the IRS telling you how big your check will be and when you can expect it. (If you didn't get a notice or have misplaced it, use our Rebate-O-Meter at Kiplinger.com to see when your check will be in the mail.)

For single taxpayers and married ones who file separately, the first $6,000 of income that used to fall in the 15% bracket now gets the 10% treatment. The same goes for $12,000 on joint returns and $10,000 on those filed by heads of household, who are usually single parents. Lopping five percentage points off the government's take means tax cuts of $300, $600 and $ 500, respectively.

But not everyone will get a full-fledged rebate. The checks can't exceed what you owed on your 2000 return--that is, your tax bill for the year, not what you owed with your return. So the millions of filers who did not owe tax will get no check. And if you owed just $250, that's what you'll get. Unless, that is, you were claimed as a dependent on your parents' tax return. Congress declared that dependents--including high school and college kids who slave away at summer jobs--don't get to ride the rebate gravy train, no matter how much tax they paid in 2000.

Down with tax rates

THE CREATION of the 10% bracket is just part of an across-the-board rate cut; other rates will gradually fall over the next few years. By 2006, the 28% bracket will be replaced by a 25% bracket; the 31% bracket will become 28%; the 36% bracket will fall to 33%; and the top, 39.6% rate will fall to 35%. (The part of the 15% bracket that doesn't dip to 10% holds steady.) You'll see the impact of these cuts in reduced withholding from your paychecks, probably starting this August.

This year's installment is a modest trim--just one-half percentage point in each of the four highest brackets. So, for example, the 28% rate falls to 27.5%, and the 39.6% bracket slides to 39.1%. Here is how reduced Withholding will affect paychecks:

A single person who earns $40,000 and claims a single withholding allowance: Take-home pay rises $7 a month. A married worker who earns $100,000 and claims four allowances: Take-home rises $32 a month.

President George W. Bush, based on his $400,000 salary and assuming four allowances: Take-home pay rises $282 each month.

Another dip in withholding will come in January, when the 10% bracket is built into the withholding tables and rates in the higher brackets dip another one-half percentage point.

Although Congress wouldn't go along with President Bush's call to cut the top tax rate to 33%, the lawmakers did agree to eliminate--starting in 2006--two provisions that now sneakily add to the tax burden of higher-income taxpayers. Those rules take away part of the value of itemized deductions and personal exemptions when adjusted gross income exceeds $132,950 (AGI is basically income before subtracting exemptions and deductions).

All for the family

THE NEW LAW is packed with goodies for families. The child credit will double to $1,000 for each child under age 17 whom you claim as a dependent. But waiting for the credit to grow up will be like waiting for adolescence to end. The credit is $600 this year (up from $500 in 2000) and will rise to $700 in 2005, to $800 in 2009 and then hit $1,000 in 2010. Of course, you're out of luck for any child who turns 17 before then. Congress chose not to increase the trigger amounts above which the child credit disappears (the phase-out starts at $75,000 for single taxpayers and $110,000 for marrieds).