Last year may go down in history for producing the most confusing piece of tax legislation ever.
How confusing? Well, it took one tax publication more than 600 pages just to describe the changes wrought by the Economic Growth and Tax Relief Reconciliation Act of 2001, including 32 pages simply to list the dates at which the law's various provisions become effective -- or expire.
The new law changes items as diverse as tax rates, IRA limits and estate tax rules. Then, barring action by Congress, on Dec. 31, 2010, the measure "sunsets" and tax law reverts to what it was at the beginning of last year.
Already, the law has led the Internal Revenue Service to add a new line to personal tax-return forms. The IRS labels it the "rate-reduction credit," but it's coming to be known as the Line That Launched a Million Errors.
But for taxpayers clutching pencils and forms in white-knuckled hands, there's a bit of good news: Most of the changes won't affect your 2001 return.
"Most of the changes don't become effective until 2002," said Arthur Auerbach, a certified public accountant with Century Business Solutions Inc. in Fairfax, Va.
But there are things that taxpayers should be conscious of this year, Auerbach and others said, not all the result of last year's legislation. Here are some:
-- The rate-reduction credit. This is Line 47 on Form 1040, Line 30 on the 1040A form and Line 7 on the 1040EZ. The credit is meant to allow taxpayers who were entitled to last year's $300 "rebate" ($600 for a couple) but didn't get it to claim it on their returns now.
You'll recall that when Congress installed a new 10 percent bracket it meant that taxpayers would pay less for 2001. But instead of making them wait for a larger refund this spring, the lawmakers called for the Treasury Department to send out the refund in advance. The agency did so, but it had to do a bit of guessing about who was entitled to the money, and inevitably it missed some eligible taxpayers.
"For most people it's not really very confusing," Auerbach said, but originally "it was not adequately explained."
Already the service has received more than a million returns with errors resulting from the credit. Many of these involved taxpayers who claimed the credit when they weren't entitled to it because they got a full rebate check last year.
If you got the full $300 or $600, just leave the line blank. Also, if you were a dependent last year, leave it blank. If, however, you were a dependent in 2000 (and thus got no rebate check) but were not a dependent in 2001 (and thus were entitled to a rebate), you should claim the credit.
There's a work sheet in the instructions to help figure the credit. Also, if you go to the IRS Web site, www.irs.gov, go to the "search" field in the upper left and type in "rate reduction credit," you'll get a list of explanatory material.
-- Lower brackets. In addition to the new 10 percent bracket, last year's tax bill knocked half a point off the highest brackets as well. Thus, the top 39.6 percent bracket became 39.1 percent, the 36 percent bracket became 35.5 percent, the 31 percent bracket became 30.5 percent, and the 28 percent bracket became 27.5 percent. The 15 percent rate remains the same, but the 10 percent bracket was carved out of it, so the first $6,000 of taxable income ($12,000 for a married couple) is taxed at 10 percent instead of 15 percent. (Don't look for this in the tax tables this year. The benefit for 2001 has already been provided in advance through the rebate.)
Taxpayers don't have to do anything special to take advantage of the new rates. They're built into the IRS tax tables. Just make sure that any forms, publications or figures you use are for 2001.
Likewise, a number of items, such as personal exemptions and income limits for using Savings Bonds tax-free to pay for higher education, are indexed for inflation. This indexing benefits taxpayers, so, again, be sure to use the 2001 numbers.
-- Capital gains rates. Back in 1997, when it cut the top capital gains tax rate from 28 percent to 20 percent, Congress further reduced rates for assets held longer than five years, beginning after 2000. Well, last year was after 2000, so you might think these lower rates -- 18 percent and 8 percent -- would be in effect. But it's not that simple.
First, the law divides sellers into two classes: those whose normal bracket would be 15 percent or less, and those whose normal bracket would be higher than that.
Beginning last year, taxpayers in the lower bracket could qualify for the 8 percent rate on profits from the sale of stocks and other assets they'd owned for five years.
Those in the higher bracket, however, have to wait. They get the lower 18 percent rate only on assets whose five-year holding period began Jan. 1, 2001, or later.
That means assets acquired before Jan. 1, 2001, wouldn't qualify, even if held until 2006.
But there's an out, sort of. The law allows taxpayers with older assets to make a "deemed sale election" on their 2001 return. If this is done, the asset is treated as if it had been sold on Jan. 1, 2001 (or Jan. 2, 2001, for stocks and other marketable securities because the markets were closed Jan. 1), even though it hasn't actually been sold.
Taxes on any prior appreciation would be due with the 2001 return, but any subsequent gains would be taxed at 18 percent if the asset is held until 2006 or later.
"What you actually buy with this election is a (2-percentage-point) reduction in the capital gain rate," Auerbach said.
And you can still do it.
You can wait until your 2001 return is due to make this election, so there's still time, Auerbach noted.
In many cases, the 2-point rate reduction wouldn't be enough to offset paying taxes earlier. Taxpayers could benefit, however, if they have an asset that had appreciated very little or not at all by the beginning of last year.
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