Important Changes for Tax Year 2001

Since it is about time to prepare or have someone prepare your tax return, we thought you would like to know the important changes for the tax year 2001.

Reduced Tax Rates. For the tax years beginning with 2001, the income tax rates have been reduced! A portion of your income that would be subject to the 15 percent tax rate is subject to a reduced rate of 10 percent. For 2001, most individuals received the benefits of the 10 percent rate through the rate reduction credit (discussed later). A person who can be claimed as a dependent on someone else's return is not eligible for the credit, but will receive the benefits of the 10 percent rate by completing a worksheet in the form instructions.

Other Tax Rates. The other tax rates – 28 percent, 31 percent, 36 percent, and 39.6 percent – have been changed to 27.5 percent, 30.5 percent, 35.5 percent, and 39.1 percent, respectively. The reduced rates should have been reflected in amounts withheld (such as backup withholding) on certain payments made after Aug. 6, 2001.

Advanced Payment of Income Tax. If you received an advanced payment of income tax in 2001, you do not have to report this payment as income on your federal income tax return. This payment reduces your rate reduction credit, discussed next.

Rate Reduction Credit. If you did not receive the maximum advance payment in 2001, you may qualify for the rate reduction credit. You can use the worksheet in your form instructions to determine whether you can claim the credit.

Child Tax Credit. The maximum child tax credit for each child has been increased to $600. The qualifications for claiming the additional child tax credit have been changed to include a qualifying individual with fewer than three children.

Interest on Student Loans. You may be able to deduct, as an adjustment to income, interest paid on a qualified student loan. The maximum deduction is increased to $2,500.

Traditional IRA Income Limits. Generally, if you have a traditional individual retirement arrangement and are covered by an employer retirement plan, the amount of income you can have and not be affected by the deduction phase out is increased. The amounts vary depending on your filing status.

Alternative Minimum Tax. The AMT exemption amounts are increased.

Schedule D Tax Computation Simplified. The tax computation on Schedule D is now easier for most taxpayers.

Lower Capital Gains Tax. Currently, the capital gains tax rates are as follows:

• Collectibles gains and gains on qualified small business stock equal to the 1202 exclusion – 28 percent

• Unrecaptured section 1250 gains – 25 percent

• All other gains and the regular tax rate that would apply is 27.5 percent and higher – 20 percent

• All other gains and the regular tax rate that would apply is lower than 15 percent – 10 percent

A new capital gains tax of 8 percent applies to gains that are "qualified five-year." Qualified five-year gains are long-term capital gains from the sale of property that you held for more than five years and that would otherwise be subject to the 10 percent capital gains rate.

Electing to Recognize Gains on Property Held on Jan. 1, 2001. You can elect to treat certain assets held on Jan. 1, 2001, as sold and reacquired on the same date. The purpose of this is to make any future gain on the property that would otherwise be subject to the 10 percent capital gains rate eligible for the 8 percent rate if the asset is held for more than five years from the date reacquired. Incidentally, beginning in 2006, the 20 percent capital gains tax will be lowered to 18 percent for qualified five-year gains from property with a holding period that begins after 2000.

Foreign Earned Income Exclusion. The amount of foreign earned income that you can exclude is increased to $78,000.

Standard Mileage Rate. The standard mileage rate for the cost of operating your car has been increased to 34.5 cents for all business miles driven.

Earned Income Credit. The maximum amount of income you can earn and still get the earned income credit has increased. You may be able to take the credit if you earned less than $32,121 ($10,710 if you do not have any qualifying children). The maximum amount of investment income you can have and still be eligible for the credit has increased to $2,450.

Standard Deduction. The standard deduction for taxpayers who do not itemize deductions on Schedule A (Form 1040) is higher in 2001 than it was in 2000. The amount depends on your filing status.

Exemption Amount. You are allowed a $2,900 deduction for each exemption to which you are entitled. However, your exemption amount could be phased out if you have a high income.

Limit on Itemized Deductions. Some of your itemized deductions may be limited if your adjusted gross income is more than $132,950 ($66,475 if you are married and filing separately). Do not worry about your gambling losses reported on Schedule A, as they are not limited.

Social Security and Medicare Taxes. The maximum wages subject to social security tax (6.2 percent) is increased to $80,400. As in the past, all wages are subject to the Medicare tax (1.45 percent).

Name Changes. Medical savings accounts (MSAs) are now Archer MSAs. Education individual retirement accounts (Education IRAs) are now Coverdell ESAs (don't ask us why).

There are other changes, such as rules for the parent of a kidnapped child and payments to holocaust victims, but we thought they would not have broad appeal.

As always, if these changes or any other tax provisions confuse you, do not guess, seek professional help from a licensed tax practitioner.

Editor's note: Roger did his undergraduate studies in accounting at Vanderbilt University. Yolanda earned a B.S. in finance at the University of California. Roger became a California CPA in 1974. Both have done graduate work in the field of taxation. As Enrolled Agents, they are licensed by the Treasury Department to represent and defend clients before the IRS nationwide, in addition to tax preparation. Their book, The Tax Guide for Gamblers, is the most comprehensive book on the subject. See their website, www.rbstaxes.com, for more information regarding their practice, articles, and useful tax links. They do business as RBS Tax Services, are located in Las Vegas, Nevada, and can be reached at (800) 829-7271. They also maintain an office in California. Currently, they are accepting new clients for this year's taxes regardless of where they live. Ask about their early-bird discount.