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2006-2010 TAX LAW CHANGES

Summary of Tax Law Changes

A Look Ahead...

Many of the tax breaks in the recent tax relief bills were designed to be phased in over a number of years. To help you determine how the new tax law will affect your long-term plans, this article explains the changes which will come into effect through 2010.

Tax law changes from 2002 are also included because many of the new tax provisions were first introduced in that year.

Just pick a year from the list below to see what tax changes are in store.

• 2002
• 2003
• 2004
• 2005
• 2006
• 2007
• 2008
• 2009
• 2010

Expanded Student Loan Interest Deduction. Taxpayers who incur debt to pay for college are allowed to deduct the interest they pay on these loans, up to a maximum of $2,500 each year.

• Under former law, deductions for interest were available only for the first 60 months of loan payments. In 2002 and future years, you are not limited to payments made within the first 60 months.
• The income limits that determine eligibility for this deduction have been increased. The deduction is available, at least partially, for single taxpayers whose adjusted gross income (line 35 of Form 1040) is less than $65,000 (it was previously $55,000) and for married taxpayers filing jointly whose adjusted gross income is less than $130,000 (up from $75,000).

New College Tuition Deduction. Starting in 2002, there is a new deduction on line 26 of Form 1040 for qualified college education costs, such as tuition and fees. This deduction applies to taxpayers who are attending college themselves OR who are paying for their children’s or spouse’s college education.

• Qualified education costs DO NOT include any amounts paid for room and board, transportation, insurance, books, or student supplies or equipment.
• For 2002 and 2003, the maximum deduction is $3,000 for single taxpayers with an adjusted gross income (AGI) of $65,000 or less, and for married taxpayers with an AGI of $130,000 or less.

Increased Retirement Contribution Limits. The changes for 2002 are as follows:

• The maximum IRA (traditional or Roth) contribution increases from $2,000 to $3,000 per person
• The maximum 401(k) and 403(b) employee contribution increases to $11,000
• The maximum combined employee and employer contributions that you can make to a qualified retirement plan each year increases to 100% of your pay or $40,000, whichever is less. The maximum was previously the lesser of 25% of your pay or $35,000.
• Taxpayers who are at least age 50 before the end of 2002 can increase their contribution limits by the following amounts for the following plans (called the catch-up contribution limit):
  • An additional $1,000 for 401(k), 403(b), salary reduction SEP plans, and 457 plans
  • An additional $500 for SIMPLE plans
  • An additional $500 for IRAs (both traditional and Roth IRAs)

Increased Retirement Plan Rollover Flexibility. Starting in 2002, participants in a retirement plan can transfer money from one plan to another when changing jobs. For example, a teacher who participated in a 403(b) annuity plan can transfer his account balance to a 401(k) plan offered by his new corporate employer. Prior to this law change, his only option was to move his 403(b) balance into an IRA account.

New Retirement Contribution Credit. This credit applies to single individuals with AGIs of less than $25,000, heads of household with AGIs less than $37,500, and married couples with AGIs less than $50,000. The contribution credit is only available from 2002 through 2006.

• If you fit the income requirements, you can receive a maximum credit of up to 50% of your elective deferrals (401(k) and 403(b) plans) and IRA contributions up to $2,000. The credit percentage varies from 10% to 50% depending on income.
• This credit is in addition to (NOT instead of) the exclusion or deduction from income for making elective deferrals and IRA contributions.

Increased Education Savings Account Contribution Limit. Education savings accounts (also known as Coverdell Accounts) can be used by taxpayers saving for future education expenses.

• For 2002 and future years, the amount that you can contribute to an education savings account increases to $2,000 (from $500 for 2001) each year for each child or other beneficiary. If you contribute $2,000 each year for 18 years, an Education Savings Account at an 8% annual earnings rate will grow to almost $80,000.
• Although your contribution to an Education Savings Account isn’t tax-deductible, the money is tax-free when it is withdrawn to pay for elementary, secondary, or post-secondary educational expenses. Income limits do apply, however: you can’t contribute to an Education Savings Account if your adjusted gross income is over $220,000 for married couples. For singles, the limit is $110,000.
• Contributors have until April 15 to make contributions (changed from December 31 in previous years).

New Educators Deduction. Starting in 2002, elementary and secondary school teachers, counselors, principals and aides are allowed a deduction of up to $250 per year for unreimbursed school expenses. Qualified expenses include books, supplies (other than nonathletic supplies for courses in health or physical education), computer equipment and supplementary materials used in the classroom. The deduction is only available in 2002 and 2003.

Increased Maximum Adoption Credit. The maximum adoption credit for qualified adoption expenses (and the maximum exclusion for employer-provided adoption benefits) increases to $10,000 in 2002, up from $5,000 in 2001. Further, the income range over which the credit is phased out increases to $150,000 - $190,000.

Increased Self-Employed Health Insurance Deduction. Self-employed taxpayers who pay for their own health insurance and who are not covered under a spouse’s health plan can deduct the health insurance premiums. This deduction increases to 70% of the cost of the health insurance, up from 50% in 2001.

Additional First-Year Depreciation. Individuals who acquire qualifying property for use in their business are allowed to take an additional 30% depreciation deduction in 2002.

Lower Income Tax Rates. Tax rates were lowered across the four highest income tax brackets. These rates are now 25%, 28%, 33%, and 35%. In addition, the 10% tax rate is now applicable to the first $7,000 of taxable income ($14,000 if you're married and file a joint tax return, or $10,000 if you file as head of household).

Reduction in Capital Gain Tax Rates. A capital gain is income from the sale of a capital asset, such as a stock or mutual fund. Before 2003, the maximum long-term (assets held longer than 1-year) capital gains tax rate was 20%. A lower 10% tax rate was used by individuals in the 10% and 15% tax brackets.

• The 2003 tax legislation replaces the 20% maximum tax rate with 15%, and replaces the 10% maximum rate with a 5% rate.
• This rate reduction applies only to sales of capital assets after May 5, 2003. For sales on or before this date, the old capital gain tax rates apply.

Reduction in Dividend Tax Rates. Before 2003, most dividend income from stocks and mutual funds was taxed as ordinary income at the taxpayer’s highest marginal tax rate. The 2003 tax bill made dividends taxable at 15% for taxpayers who are in a tax bracket above 15%, and at 5% for taxpayers in the 10% and 15% tax brackets.

Marriage Penalty Relief. Married couples are often faced with a larger tax bill than they would have paid if they had filed as single taxpayers. The tax legislation of 2001 and 2003 made the following changes to reduce this inequity:

• Before 2003, the standard deduction for married couples was only 167% of that for singles. For 2003 and 2004, the standard deduction is increased to 200% of the single filer’s deduction.
• Before 2003, the endpoint of the married 15% tax bracket (taxable income from $14,000 to $56,800) was about 167% of that for a single filer. In 2003 the 15% tax bracket increases so that it is double the single filer’s amount.

Increased Child Tax Credit. Taxpayers who have a qualifying dependent child are eligible for the child tax credit. The credit increases from $600 in 2002 to $1,000 in 2003. A qualifying child must be under 17 at the end of the calendar year, a U.S. citizen or resident alien, and must be either:

• the taxpayer’s child, stepchild, sibling, step-sibling, or
• a descendent of any of these, or
• an eligible foster child

Increased Child & Dependent Care Credit. A tax credit is available for qualifying child and dependent care expenses paid for the purpose of allowing the taxpayer(s) to work. The maximum expense eligible for the Dependent Care Credit increases in 2003 to $3,000 for one child, and to $6,000 for two or more children.

• In the case of a married couple, both spouses generally must work in order to be eligible for the credit.
• In 2003 and future years, the maximum percentage of expenses allowed for the credit increases to 35% for families with adjusted gross income of $15,000 or less. For taxpayers with income above this level, the maximum credit percentage gradually declines to a minimum of 20% when income exceeds $43,000.

Increased Retirement Contribution Limits. The changes for 2003 are as follows:

• The maximum 401(k) and 403(b) employee contribution increases to $12,000
• The maximum SIMPLE employee contribution increases to $8,000.
• Taxpayers who are at least age 50 before the end of 2003 can increase their contribution limits by the following amounts for the following plans (called the catch-up contribution limit):
  • An additional $2,000 for 401(k), 403(b), salary reduction SEP plans, and 457 plans
  • An additional $1,000 for SIMPLE plans

Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $70,000 (married filing joint) or $50,000 (single or head of household).

Increased Lifetime Learning Credit. This tax credit is available for taxpayers who pay qualified tuition expenses while pursuing college or graduate degrees or vocational training. Qualified tuition expenses do NOT include room and board, books, student health fees, or transportation.

• For 2003 and future years, the maximum amount of expenses available for this credit is increased to $10,000, up from $5,000 in 2002.
• The credit is equal to 20% of qualified expenses, and begins to be phased out (reduced) for taxpayers with adjusted gross income of $41,000, or $83,000 if married filing jointly. The credit is completely phased out for single taxpayers with incomes over $51,000 ($103,000 for married taxpayers).

Increased Maximum Adoption Credit. The maximum adoption credit for qualified adoption expenses (and the maximum exclusion for employer-provided adoption benefits) increases to $10,160, up from $10,000 in 2002. Further, the income range over which the credit is phased out increases to $152,339 - $192,339.

Increased Self-Employed Health Insurance Deduction. Self-employed taxpayers who pay for their own health insurance and who are not covered under a spouse’s health plan can deduct the health insurance premiums. This deduction has been increased to 100% of the cost of the health insurance, up from 70% in 2002.

Additional First-Year Depreciation. Individuals who acquire qualifying property for use in their business are allowed to take an additional 50% depreciation deduction in 2003. The property must be purchased after May 5, 2003 to qualify for the 50% special depreciation allowance; for property purchased between January 1 and May 5, the special allowance is 30%.

Increased Section 179 Expense Deduction. Taxpayers who purchase qualifying business property may elect to deduct the cost of the property (new or used) in the year that it is placed in service. This is referred to as a Section 179 deduction. For 2003, the maximum amount of property that may be taken as a Section 179 deduction is increased from $25,000 to $100,000.

Increased Retirement Contribution Limits. The changes for 2004 are as follows:

• The maximum 401(k) and 403(b) employee contribution increases to $13,000
• The maximum SIMPLE employee contribution increases to $9,000.
• Taxpayers who are at least age 50 before the end of 2004 can increase their contribution limits by the following amounts for the following plans (called the “catch-up” contribution limit):
  • additional $3,000 for the 401(k), 403(b), salary reduction SEP plans, and 457 plans
  • An additional $1,500 for SIMPLE plans

Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $75,000 (married filing joint) or $55,000 (single or head of household).

Increased College Tuition Deduction. Applies to taxpayers who are attending college themselves OR who are paying for their children's or spouse’s college education. For 2004 and 2005, the maximum deduction will increase to $4,000 for single taxpayers with an adjusted gross income (AGI) of $65,000 or less, and for married taxpayers with an AGI of $130,000 or less. A lower deduction of $2,000 will be available for single taxpayers with AGIs between $65,000 and $80,000, and married taxpayers with AGIs between $130,000 and $160,000.

Educators Deduction. This deduction expires after 2003, and therefore is no longer available in 2004.

Decreased Child Tax Credit. Taxpayers who have a qualifying dependent child are eligible for the child tax credit. The credit decreases from $1,000 in 2004 to $700 in 2005.

Increased Retirement Contribution Limits. The changes for 2005 are as follows:

• The maximum IRA (traditional or Roth) contribution increases from $3,000 to $4,000 per person
• The maximum 401(k) and 403(b) employee contribution increases to $14,000
• The maximum SIMPLE employee contribution increases to $10,000.
• Taxpayers who are at least age 50 before the end of 2005 can increase their contribution limits by the following amounts for the following plans (called the catch-up contribution limit):
  • An additional $4,000 for 401(k), 403(b), salary reduction SEP plans, and 457 plans
  • An additional $2,000 for SIMPLE plans

Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $80,000 (married filing joint) or $60,000 (single or head of household).

Marriage Penalty. Married couples are often faced with a larger tax bill than they would have paid if they had filed as single taxpayers. The tax legislation of 2001 and 2003 made changes to reduce this inequity; however, these changes expire after 2004, so the marriage penalty gets worse in 2005 for some taxpayers:

• In 2003 and 2004, the standard deduction for married couples is 200% of that for singles. In 2005, the married standard deduction drops back down to 175% of the single filer’s deduction.
• In 2003 and 2004, the endpoint of the married 15% tax bracket is 200% of that for singles. In 2005, the 15% tax bracket drops back down to 180% of the single filer’s amount.

Increased Retirement Contribution Limits. The changes for 2006 are as follows:

• The maximum 401(k) and 403(b) employee contribution increases to $15,000
• Taxpayers who are at least age 50 before the end of 2006 can increase their contribution limits by the following amounts for the following plans (called the catch-up contribution limit):
  • An additional $5,000 for 401(k), 403(b), salary reduction SEP plans, and 457 plans
  • An additional $2,500 for SIMPLE plans
  • An additional $1,000 for IRAs (both traditional and Roth IRAs)

Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $85,000 (married filing joint) or $60,000 (single or head of household).

Decreased Section 179 Expense Deduction. Taxpayers who purchase qualifying business property may elect to deduct the cost of the property (new or used) in the year that it is placed in service. This is referred to as a Section 179 deduction. In the tax years 2003 - 2005, the maximum amount of property that may be taken as a Section 179 deduction is $100,000. In 2006 and future years, the maximum deduction drops to $25,000.

First-Year Depreciation. Individuals who acquire qualifying property for use in their business are allowed to take an additional 50% depreciation deduction for property purchased in 2003, 2004, or 2005. This special depreciation allowance expires after 2005, and therefore is no longer available in 2006.

College Tuition Deduction. This deduction expires for tax years after 2005.

Reduction in Itemized Deduction Limits for High-Income Taxpayers. Currently, itemized deductions are phased out (reduced) as your income rises. Starting in 2006, the deduction phase out will be reduced by one third. In 2008, it will be reduced by two thirds, and in 2010, the phase out will disappear entirely.

Starting in 2007

Retirement Contribution Credit. This credit, which first came into effect in 2002, expires after 2006 and therefore is no longer available.

Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $90,000 (married filing joint) or $60,000 (single or head of household).

Reduction in Capital Gain Tax Rates. Capital gains are income from sales of capital assets (stocks, mutual funds, etc.). Before 2003, the maximum long-term (assets held longer than 1-year) capital gains tax rate was 20%. A lower 10% tax rate was used by individuals in the 10% and 15% tax brackets. For tax years 2003-2007, the 2003 tax legislation replaces the 20% maximum tax rate with 15%, and replaces the 10% maximum rate with 5%. In 2008, the 5% maximum rate drops to 0%. The 15% tax rate stays the same.

Reduction in Dividend Tax Rates. Before 2003, most dividend income from stocks and mutual funds was taxed as ordinary income at the taxpayer’s highest marginal tax rate. For tax years 2003-2007, the 2003 tax bill made dividends taxable at 15% for taxpayers above the 15% tax bracket, and at 5% for taxpayers in the 10% and 15% tax brackets. In 2008, the 5% tax rate for dividends drops to 0%. The 15% tax rate stays the same.

Increased Retirement Contribution Limits. The only change to retirement contribution limits for 2008 is the maximum IRA (traditional or Roth) contribution increases from $4,000 to $5,000.

Marriage Penalty Relief. Married individuals are often faced with a larger tax bill than they would have paid if they had filed as single taxpayers. The tax legislation of 2001 and 2003 made changes to reduce this inequity in 2003 and 2004. These changes were reversed to a certain extent for tax years 2005 - 2007, but are scheduled to come back in 2008 and 2009.

Increase in Capital Gain and Dividend Tax Rates. The tax rate reductions for long-term capital gains and dividends which are in effect from 2003 – 2008 expire this year.

• In 2009, the maximum long-term capital gain tax rate goes back up to 20%. A lower 10% tax rate is used by individuals in the 10% and 15% tax brackets.
• In 2009, most dividend income from stocks and mutual funds is taxed as ordinary income at the taxpayer’s highest marginal tax rate.
  
  Starting in 2010

  Increased Child Tax Credit. Taxpayers who have a qualifying dependent child are eligible for the child tax credit. The credit increases from $800 in 2009 to $1,000 in 2010.