Economic Growth and Tax Relief Reconciliation Act of 2001
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The Economic Growth and Tax Relief Reconciliation Act of 2001 was a sweeping piece of tax legislation in the United States. It is commonly known by its abbreviation EGTRRA, often pronounced "egg-tra" or "egg-terra", and sometimes also known simply as the 2001 act, especially when it is clear the context of the discussion is regarding taxes. It had major impact and changes in many areas of the US Internal Revenue Code including income tax rates, estate and gift tax exclusions, and qualified and retirement plan rules. In general the act lowered tax rates and simplified retirement and qualified plan rules such as for Individual retirement accounts, 401(k) plans, 403(b), and pension plans. The changes were so large and numerous that many many books and analysis papers were published regarding the changes and how to best take advantage of them.
Many of the tax reductions in EGTRRA were designed to be phased in over a period of up to 9 years. Many of these slow phase-ins were accelerated by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), which removed the waiting periods for many of EGTRRA's changes.
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Sunset Provision
One of the most notable characteristics of EGTRRA is that its provisions are designed to sunset, or revert to the provisions that were in effect before it was passed. EGTRRA will sunset on Jan 1, 2011 unless further legislation is enacted to make its changes permanent. The sunset provision sidesteps the congressional rule that tax cuts, unaccompanied by spending cuts, can not exceed a $1.35 trillion 11 year limit.
One of the more interesting aspects of this provision is that the estate tax would be repealed in 2010 but would reappear in 2011. Only people who die in 2010 could pass on their fortunes with no estate tax, though heirs would face an expanded capital gains tax starting that year. Those with estates worth up to $3.5 million would escape taxes by dying in 2009, when that much inheritance would be exempt from estate taxes and heirs would not yet be hit by the new capital gains tax.
Impact of the Alternative Minimum Tax
EGTRRA and the 2003 act significantly nominally lowered the marginal tax rates for nearly all US taxpayers. However by doing this it brought to prominence a previously lesser known provision of the US Internal Revenue Code, known as the Alternative minimum tax. The Alternative Minimum Tax, AMT was originally designed as a way of making sure that wealthy taxpayers could not take advantage of "too many" tax incentives and reduce their tax obligation by too much. It is an alternate system of calculating a taxpayer's tax liability that removes many so called "tax preference items". However the applicable AMT rates were not adjusted in step with the lowered rates of EGTRRA and the 2003 act, causing many more people to face higher taxes because of the AMT than had originally been planned. This reduced some of the benefit of EGTRRA and the 2003 act for many middle income earners.
Major tax areas impacted
Income tax
EGTRRA generally reduced rates and steepend the progressivity of individual income taxes:
- a new 10% bracket was created for single filers with income up to $6,000, joint filers up to $12,000, and heads of households up to $10,000.
- the 15% bracket's lower threshold was indexed to the new 10% bracket
- the 28% bracket would be lowered to 25% by 2006.
- the 31% bracket would be lowered to 28% by 2006
- the 36% bracket would be lowered to 33% by 2006
- the 39.6% bracket would be lowered to 35% by 2006
EGTRRA substantially reduced the so-called "marriage penalty," by increasing the standard deduction for joint filers to between 174% and 200% of the deduction for single filers.
Additionally, it changed the rate of tax on dividend income starting in 2003 to 5% for those in the 0% or 15% brackets, falling to 0% in 2008. It was lowered to 15% for all other brackets.
Additionally, EGTRRA increased the per-child tax credit and the amount eligible for credit spent on dependent child care, phased out limits on itemized deductions and personal exemptions for higher income taxpayers, and increased the exemption for the Alternative Minimum Tax, and created a new depreciation deduction for qualified property owners.
See Effective Federal Tax Rates Under Current Law, 2001 to 2014 (http://www.cbo.gov/showdoc.cfm?index=5746), by the Congressional Budget Office.
Capital gains tax
Effective May 6, 2003, the capital gains tax was reduced to 5% for taxpayers in the 0% or 15% brackets, and to 0% in 2008. For other taxpayers, it was lowered to 15% for other taxpayers (10% for joint, and 20% for head of household).
Qualified and retirement plans
EGTRRA introduced sweeping changes to retirement plans, incorporating many of the so-called Portman-Cardin provisions proposed by those House members in 2000 and earlier in 2001. Overall it raised pre-tax contribution limits for defined contribution plans and Individual Retirement Accounts (IRAs), increased defined benefit compensation limits, made non-qualified retirement plans more flexible and more similar to qualified plans such as 401(k)s, and created a "catch-up" provision for older workers.
EGTRRA allows, for the first time, for participants in non-qualified 401(a) money purchase, 403(b) tax-sheltered annuity, and governmental 457(b) deferred compensation plans (but not tax-exempt 457 plans) to "rollover" their money and consolidate accounts, whether to a different non-qualified plan, to a qualified plan such as a 401(k), or to an IRA.
The so-called "catch-up" provision allows employees over the age of 50 to make additional contributions to their retirement plans over and above the normal limits. For workers who are already retired, the law raises the age for minimum required distributions (MRDs), directing the Treasury to revise its life expectancy tables and simplify MRD rules.
EGTRRA created two new retirement savings vehicles. The Deemed IRA or Sidecar IRA is a Roth IRA attached as a separate account to an employer-sponsored retirement plan; while the differing tax treatment is preserved for the employee, the funds may be commingled for investment purposes. It is an improvement upon the unpopular qualified voluntary employee contribution (QVEC) provision developed in the early 1980s. The so-called Roth 401(k)/403(b) is a new tax-qualified employer-sponsored retirement plan to become effective in 2006, and would offer tax treatment in a retirement plan similar to that offered to account holders of Roth IRAs.
For plan sponsors, the law requires involuntary cash-out distributions of 401(k) accounts into a default IRA. It accelerates the mandatory vesting schedule applied to matching contributions, but increases the portion of employer contributions permitted from profit sharing. Small employers are granted tax incentives to offer retirement plans to their employees, and sole proprietors, partners and S corporation shareholders gain the right to take loans from their company pension plans.