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Some tax law changes now, more on the horizon

The Economic Growth and Tax Relief Reconciliation Act passed in 2001 produced the most comprehensive tax law changes in 20 years. Breaks were added to help parents, married couples and heirs, as well as increase options for retirement accounts and education expenses.

The benefits, however, will be parceled out over several years, with most of the relief coming between 2008 and 2010. After that, it's up to lawmakers to keep the laws or rewrite them. Our advice: Take advantage of these tax savings as soon as they are available. You never know how long they'll be around.

Falling rates
On Jan. 1, 2002, tax rates dropped again for the top four brackets. Income at these levels is now taxed at 27 percent, 30 percent, 35 percent and 38.6 percent. They will stay at this level for 2003, then continue to edge down incrementally. By 2006, the upper brackets will be 25 percent, 28 percent, 33 percent and 35 percent.

Child tax credit
The child tax credit will hold at $600 per youngster through 2004. After that, the credit will increase gradually over the next few years, topping out at $1,000 per child by 2010.

If you put the kids in day care while you work, you'll get a bit more tax help paying for it. The available dependent care credit amount this year goes to $3,000 (from $2,400) for each child. Plus, the income level at which a taxpayer would lose part of the care credit rises to $15,000 (from $10,000), meaning more parents should be able to get the credit's full benefit.

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Adoption costs
Adoptive parents get several breaks. The adoption tax credit will now help defray up to $10,000 of adoption expenses, double the previous credit for costs associated with adopting a child who does not have special needs. This increase also is available for adoptions of special-needs children, previously a $6,000 limit. And the income level at which the credit is reduced is doubled to $150,000.

Retirement accounts
Tax-deferred retirement options have increased. You can put $3,000 into an individual retirement account in for tax years 2002 through 2004. That includes amounts put into either a traditional IRA or a Roth account. Persons 50 or older can add another $500 to that kitty in filing years 2002 through 2005. IRA contribution limits will continue to rise under the new laws, topping out at $5,000 in 2008.

Law changes also make it easier for workers to roll over 401(k) and other company pensions when they change jobs and now allow for the rollover of "after-tax" contributions. As with IRAs, the amounts that employees (and older workers) can contribute to work-place accounts are increased.

Educational savings
The legislation creates several education-related breaks.

  • Withdrawals from state-sponsored prepaid tuition plans are completely tax-free.
  • A new college expense tax credit of up to $3,000 will appear on 2002 returns and will be available to taxpayers who earn too much money to claim the Hope or Lifetime Learning credits. This break, however, is scheduled to disappear in 2006.
  • The 60-month limit on the existing student loan interest deduction has been eliminated.

And the education IRA is now called the Coverdell Education Savings Account, in honor of the late U.S. Sen. Paul Coverdell of Georgia. Along with the new name, the account's contribution limit has quadrupled to $2,000 a year. Allowable expenses also have been broadened to include tuition, room and board, books and computer costs for public, private or parochial schooling at the primary and secondary levels. Money now can be contributed to a Coverdell account for a child even if contributions are made to a state tuition program for that student.

Estate taxes
If you inherit rich Uncle Bill's estate in the next few years, there should be more for you. The tax-law changes now protect assets up to $1 million from federal estate taxation. Estate exemption amounts will continue to increase, hitting $3.5 million in 2009.

For large estates that will still owe the tax, the rate at which the excess will be taxed drops by a few percentage points each year from the pre-law-change high of 55 percent. By 2009, the tax rate on amounts over $3.5 million will be 45 percent.

And in 2010, and that year only unless Congress extends the law, the estate tax is repealed.

Marriage penalty
Married taxpayers, too, will get relief from the marriage tax penalty. But couples who find they pay more when they file jointly than they would if they filed as single taxpayers will have to wait a bit longer for their tax break.

Changes to increase the standard deduction for married joint filers and widen the 15-percent tax bracket for them won't go into effect until 2005. By 2008, the 15-percent tax bracket will be twice that of single filers, meaning more joint income will be taxed at this lower rate. A year later, the standard deduction for couples will be double that of single taxpayers.

-- Updated: Sept. 24, 2002

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See Also
MAIN: Tax changes and your 2001 return
Tips to make early tax-filing easier
Getting the most from itemized deductions
More tax stories
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