Clergy Tax Developments in 2001

Article summary. On June 7, 2001, President Bush signed a massive new tax law known as the Economic Growth and Tax Relief Reconciliation Act of 2001 (referred to simply as "EGTRRA" in this article). While EGTRRA's most prominent feature is a $1.35 trillion tax-cut package, the new law also makes more than 440 other changes to the Internal Revenue Code. We have carefully reviewed the entire text of this massive law, and are summarizing in this article those provisions that are of most relevance to ministers and church treasurers. There were other significant tax developments that occurred in 2001, including several important court cases and IRS rulings. These developments are summarized in this article as well.

Key point. An unprecedented feature of EGTRRA is a "sunset" provision that revokes all of the hundreds of tax law changes at the end of 2010 unless Congress votes to extend them. If Congress fails to take action, then the tax law in effect in 2001 will be reinstated. Because many taxpayers, in all income brackets, will increasingly rely on many of the tax law changes in the new law, it is inconceivable that Congress will allow all of the changes to expire at the end of 2010. It is reasonable to assume that many of the changes will be permanently adopted by Congress, but not necessarily all of them.

Tax Law Changes Made by EGTRRA

Individual Income Taxes

1. Reduction in income tax rates. Income taxes are computed by applying the applicable income tax rates to taxable income. EGTRRA creates a new 10% income tax bracket for a portion of taxable income that is currently taxed at 15%, effective for taxable years beginning after December 31, 2000. The 10% rate bracket applies to the first $6,000 of taxable income for single individuals, and $12,000 for married couples filing joint returns. This $6,000 increases to $7,000 and this $12,000 increases to $14,000 for 2008 and thereafter. The taxable income levels for the new low-rate bracket will be adjusted annually for inflation for taxable years beginning after December 31, 2008.

The 15% income tax bracket is modified to begin at the end of the new low-rate regular income tax bracket. The 15% income tax bracket ends at the same level as under present law. The 15% bracket is also adjusted in order to minimize the effect of the so-called "marriage penalty." This is addressed later in this chapter.

The pre-EGTRRA income tax rates of 28%, 31%, 36%, and 39.6% are phased down over six years to 25%, 28%, 33%, and 35%, effective after June 30, 2001, as described in Table 1. Since the tax rate changes do not take effect until July 1, 2001, rate reductions for 2001 will come in the form of a "blended" tax rate. The taxable income levels for the new rates in all taxable years are the same as the taxable income levels that apply under the present-law rates.

Table 1: Income Tax Rate Reductions

calendar year	28% rate reduced to:	31% rate reduced to:	36% rate reduced to:	39.6% rate reduced to:
2001	27.5%	30.5%	35.5%	39.1%
2002-2003	27%	30%	35%	38.6%
2004-2005	26%	29%	34%	37.6%
2006 and later	25%	28%	33%	35%

Tables 2 and 3 show the tax rates and corresponding income levels for the year 2006, when the rate cuts are fully effective. Note that the income levels in these tables are projected amounts.

Table 2: Income Tax Rates for 2006 (Single Persons)

 

taxable income		pay	plus the	of taxable
over	but not over		following	income
			percent	exceeding
$0	$6,000	$0	10%	$0
$6,000	$30,950	$600	15%	$6,000
$30,950	$74,950	$4,342	25%	$30,950
$74,950	$156,300	$15,342	28%	$74,950
$156,300	$339,850	$38,120	33%	$156,300
$339,850		$98,692	35%	$339,850

Table 3: Income Tax Rates for 2006 (Married Persons Filing Jointly)

 

taxable income		pay	plus the	of taxable
over	but not over		following	income
			percent	exceeding
$0	$12,000	$0	10%	$0
$12,000	$57,850	$1,200	15%	$12,000
$57,850	$124,900	$8,077	25%	$57,850
$124,900	$190,300	$24,840	28%	$124,900
$190,300	$339,850	$43,152	33%	$190,300
$339,850		$92,503	35%	$339,850

Table 4 shows the federal income tax that would be paid by a married couple filing jointly under several different levels of taxable income, in 2001 (without the EGTRRA tax reductions), in 2001 (with the EGTRRA tax reductions for that year), and in 2006. Note the following: (1) The table only reflects federal income taxes. Social security and state and local taxes are not included. (2) The 2006 taxes use estimated amounts of taxable income that will be needed to trigger the corresponding tax rates. The actual taxes in 2006 may be slightly different.

Table 4: The Bottom Line—Tax Savings Under Different Scenarios

taxable income (married, filing jointly), after credits	2001 taxes rates (pre-EGTRRA), with effective tax rate in brackets	2001 taxes (with EGTRRA changes), with effective tax rate in brackets	tax savings in dollars over pre-EGTRRA rates [percentage drop in taxes in brackets]	2006 taxes (with EGTRRA changes), with effective tax rate in brackets	tax savings in dollars over pre-EGTRRA rates [percentage drop in taxes in brackets]
$10,000	$1,500 [15%]	$1,000 [10%]	$500 [33%]	$1,000 [10%]	$500 [33%]
$25,000	$3,750 [15%]	$3,150 [13%]	$600 [16%]	$3,150 [13%]	$600 [16%]
$50,000	$8,124 [16%]	$7,500 [15%]	$624 [8%]	$6,900 [14%]	$1,224 [15%]
$75,000	$15,124 [20%]	$14,375 [19%]	$749 [5%]	$12,364 [16%]	$2,760 [18%]
$100,000	$22,124 [22%]	$21,250 [21%]	$874 [4%]	$18,614 [19%]	$3,510 [16%]

2. Rate reduction credit for 2001. One of the purposes behind the new 10% tax rate was to provide a stimulus to the economy. In order to achieve this stimulus more quickly, EGTRRA allows a rate reduction credit in lieu of the new 10% tax rate for 2001, and this credit will be distributed in advance to eligible taxpayers in the form of a check from the Treasury Department. The 2001 advance payment amount is 5% (the difference between the 15% and the 10% rates) of the amount of "taxable income" shown on a taxpayer's 2000 tax return (less any credits), up to a maximum of $300 for a single taxpayer and $600 for a married couple filing a joint return. Taxable income is reported on line 51 of Form 1040, line 33 of Form 1040A, and line 10 of Form 1040EZ. Most taxpayers received the full amount as an advance payment in 2001; some will have it split between 2001 and 2002; and some may get all of it as a credit on the 2001 tax return.

3. Elimination of the "marriage penalty." When two persons are married, they often pay more taxes than if they had remained single. There are two reasons. First, their combined income may put them in a higher tax bracket; and second, the standard deduction for a married couple is less than the standard deductions for two single persons. These two consequences are generally referred to as the "marriage penalty." EGTRRA reduces this penalty in the following two ways:

#1--income tax rates

The income tax rates prior to EGTRRA (15%, 28%, 31%, 36%, 39.6%) each applied to a  specific range of taxable income, with higher amounts of income triggering higher tax rates. As a result, two wage-earners generally paid more in taxes if they were married than if they remained single since their income was combined for purposes of applying the tax rates. The tax code "penalized" them for marrying. EGTRRA minimizes the effect of the marriage penalty by increasing the 15% income tax rate for a married couple filing a joint return to twice the size of the corresponding rate for a single person filing a single return. The increase is phased-in over four years, beginning in 2005. Therefore, this provision is fully effective (i.e., the size of the 15% income tax rate bracket for a married couple filing a joint return would be twice the size of the 15% tax rate bracket for single persons) for taxable years beginning after December 31, 2007. Table 5 summarizes the phase-in of this new rule.

Table 5: Increase in Size of 15% Rate for Married Couples Filing a Joint Return

taxable year	end point of 15% rate bracket for married couple filing jointly as a percentage of end point of 15% rate bracket for single persons
2005	180%
2006	187%
2007	193%
2008 and thereafter	200%

#2--the standard deduction

The standard deduction for married persons filing jointly is increased, beginning in 2005, to minimize the marriage penalty. Table 6 summarizes this change.

Table 6: Increase in the Standard Deduction

calendar year	standard deduction for joint returns as percentage of standard deduction for single returns
2005	174%
2006	184%
2007	187%
2008	190%
2009 and later	200%

4. Increase and expand the child tax credit. Prior to EGTRRA an individual could claim a $500 tax credit for each qualifying child under the age of 17. In general, a qualifying child is an individual for whom the taxpayer can claim a dependency exemption and who is the taxpayer’s son or daughter (or descendent of either), stepson or stepdaughter, or eligible foster child. The child tax credit is phased-out for individuals with income over certain thresholds. Specifically, the credit is reduced by $50 for each $1,000 (or fraction thereof) of modified adjusted gross income over $75,000 for single individuals or $110,000 for married individuals filing joint returns. Modified adjusted gross income is the taxpayer’s total gross income plus certain amounts excluded from gross income (such as the foreign earned income exclusion). The length of the phase-out range depends on the number of qualifying children. The child tax credit is not adjusted annually for inflation. EGTRRA increases the child tax credit to $1,000, phased-in over ten years, beginning in 2001.

 

Table 7: Increase in the Child Tax Credit

calendar year	credit amount per child
2001-2004	$600
2005-2008	$700
2009	$800
2010 and later	$1,000

5. Expansion of dependent care credit. A taxpayer who maintains a household that includes one or more qualifying individuals may claim a nonrefundable credit against income tax liability for up to 30% of a limited amount of employment-related expenses. Eligible employment-related expenses are limited to $2,400 if there is one qualifying individual or $4,800 if there are two or more qualifying individuals. Thus, the maximum credit is $720 if there is one qualifying individual and $1,440 if there are two or more qualifying individuals. A qualifying individual is (1) a dependent of the taxpayer under the age of 13 for whom the taxpayer is eligible to claim a dependency exemption, (2) a dependent of the taxpayer who is physically or mentally incapable of caring for himself or herself, or (3) the spouse of the taxpayer; if the spouse is physically or mentally incapable of caring for himself or herself. The 30 percent credit rate is reduced, but not below 20 percent, by 1 percentage point for each $2,000 (or fraction thereof) of adjusted gross income above $10,000.

EGTRRA makes the following changes in these rules, beginning in 2003:

• It increases the maximum amount of eligible employment-related expenses from $2,400 to $3,000, if there is one qualifying individual (from $4,800 to $6,000, if there are two or more qualifying individuals).

• It increases the maximum credit from 30% to 35% (the maximum credit is $1,200, if there is one qualifying individual and $2,400, if there are two or more qualifying individuals).

• It modifies the phase-down of the credit. The 35% credit rate is reduced, but not below 20 percent, by 1 percentage point for each $2,000 (or fraction thereof) of adjusted gross income above $15,000. Therefore, the credit percentage is reduced to 20 percent for taxpayers with adjusted gross income over $43,000.

6. Marriage penalty relief and simplification relating to the earned income credit. Eligible low-income workers are able to claim a refundable earned income credit. The amount of the credit an eligible taxpayer may claim depends upon the taxpayer’s income and whether the taxpayer has one, more than one, or no qualifying children. EGTRRA makes the following changes in the earned income credit, beginning in 2002:

• In the past, the earned income amount penalizes some individuals because they receive a smaller earned income credit if they are married than if they are not married. In order to minimize this penalty, EGTRRA increases the phase-out amount for married taxpayers who file a joint return. For married taxpayers who file a joint return, EGTRRA increases the beginning and ending of the earned income credit phase-out by $3,000. These beginning and ending points are to be adjusted annually for inflation after 2002.

• EGTRRA simplifies the definition of earned income by excluding nontaxable employee compensation from the definition of earned income for earned income credit purposes. As a result, earned income includes wages, salaries, tips, and other employee compensation, if includible in gross income for the taxable year, plus net earnings from self employment. Housing allowances, and the annual rental value of church-provided parsonages, are examples of "nontaxable employee compensation" that in the past was included in the computation of "earned income" in calculating the earned income credit. The effect was to increase earned income and either disqualify many ministers for the earned income credit (because their earned income was too high), or reduce the value of the credit. By eliminating housing allowances and the annual rental value of parsonages from the definition of earned income, EGTRRA will make the earned income credit available to many more ministers, and will result in a larger credit for those who qualify for the credit.

• EGTRRA simplifies the calculation of the earned income credit by replacing modified adjusted gross income with adjusted gross income.

• EGTRRA provides that the "relationship test" is met if the individual is the taxpayer’s son, daughter, stepson, stepdaughter, or a descendant of any such individuals. A brother, sister, stepbrother, stepsister, or a descendant of such individuals, also qualifies if the taxpayer cares for such individual as his or her own child. A foster child satisfies the relationship test as well. In order to be a qualifying child, in all cases the child must have the same principal place of abode as the taxpayer for over one-half of the taxable year.

7. Phase-out of personal exemption reduction. In order to determine taxable income, an individual reduces adjusted gross income by any personal exemptions, deductions, and either the applicable standard deduction or itemized deductions. Personal exemptions generally are allowed for the taxpayer, his or her spouse, and any dependents. For 2001, the amount deductible for each personal exemption is $2,900. This amount is adjusted annually for inflation. Prior to EGTRRA, the deduction for personal exemptions was phased-out for taxpayers with adjusted gross income over certain thresholds. For 2001, the thresholds are $132,950 for single individuals and $199,450 for married individuals filing a joint return (adjusted annually for inflation). The total amount of exemptions that may be claimed by a taxpayer is reduced by two percent for each $2,500 (or portion thereof) by which the taxpayer’s adjusted gross income exceeds the applicable threshold. For 2001, the point at which a taxpayer’s personal exemptions are completely phased-out is $255,450 for single individuals and $321,950 for married individuals filing a joint return. EGTRRA repeals the personal exemption phase-out over five years, beginning in 2006. The phase-out is reduced by one-third in taxable years beginning in 2006 and 2007, and is reduced by two-thirds in taxable years beginning in 2008 and 2009. The repeal is fully effective for taxable years beginning after December 31, 2009. In explaining the reason for repealing the phase-out, a congressional conference committee noted that "the personal exemption phase-out is an unnecessarily complex way to impose income taxes and the hidden way in which the phase-out raises marginal tax rates undermines respect for the tax laws."

8. Increase the starting point for phase-out of itemized deductions. Taxpayers may choose to claim either the standard deduction or itemized deductions (subject to certain limitations) for certain expenses incurred during the year. Prior to EGTRRA the total amount of allowable itemized deductions (with a few exceptions) was reduced by three percent of the amount of the taxpayer’s adjusted gross income in excess of $132,950 in 2001. However, itemized deductions could not be reduced by more than 80%. The starting point for the phase-out ($132,950 in 2001) was adjusted annually for inflation. EGTRRA repeals this limitation on itemized deductions over a five year period beginning in 2006. The limit on itemized deductions is reduced by one-third in taxable years beginning in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009. The overall limitation is repealed for taxable years beginning after December 31, 2009.

Education

9. Modifications to education IRAs. Current law allows taxpayers to create "education IRAs" for the purpose of paying the qualified higher education expenses of designated beneficiaries. Annual contributions to education IRAs may not exceed $500 per beneficiary (except in cases involving certain tax-free rollovers) and may not be made after the designated beneficiary reaches age 18. The $500 annual contribution limit for education IRAs is generally phased-out for single taxpayers with modified adjusted gross income between $95,000 and $110,000. The phase-out range for married taxpayers filing a joint return is $150,000 to $160,000 of modified adjusted gross income. Individuals with modified adjusted gross income above the phase-out range are not allowed to make contributions to an education IRA established on behalf of any individual. Earnings on contributions to an education IRA generally are subject to tax when withdrawn. However, distributions from an education IRA are excludable from the gross income of the beneficiary to the extent that the total distribution does not exceed the “qualified higher education expenses” incurred by the beneficiary during the year the distribution is made.

EGTRRA makes the following changes to educational IRAs, effective in 2002:

• The annual limit on contributions to education IRAs is increased from $500 to $2,000. As a result, the total contributions that may be made by all contributors to one (or more) education IRAs established on behalf of any particular beneficiary is limited to $2,000 for each year.

• The definition of "qualified education expenses" for which tax-free distributions form an education IRA may be made is expanded to include “qualified elementary and secondary school expenses,” meaning expenses for (1) tuition, fees, academic tutoring, special need services, books, supplies, computer equipment (including related software and services), and other equipment incurred in connection with the enrollment or attendance of the beneficiary at a public, private, or religious school providing elementary or secondary education (kindergarten through grade 12) as determined under state law, and (2) room and board, uniforms, transportation, and supplementary items or services (including extended day programs) required or provided by such a school in connection with such enrollment or attendance of the beneficiary. Computer software involving sports, games, or hobbies is not considered a qualified elementary and secondary school expense unless the software is predominantly educational in nature.

• The phase-out range for married taxpayers filing a joint return is increased so that it is twice the range for single taxpayers. As a result, the phase-out range for married taxpayers filing a joint return is $190,000 to $220,000 of modified adjusted gross income.

• The rule prohibiting contributions to an education IRA after the beneficiary attains 18 does not apply in the case of a special needs beneficiary (as defined by IRS regulations).

• Corporations and other entities (including tax-exempt organizations) are permitted to make contributions to education IRAs, regardless of the income of the corporation or entity during the year of the contribution.

• Individual contributors to education IRAs are deemed to have made a contribution on the last day of the preceding taxable year if the contribution is made on account of such taxable year and is made not later than April 15 of the following year.

• Taxpayers are permitted to claim a HOPE credit or Lifetime Learning credit for a taxable year and to exclude from gross income amounts distributed (both the contributions and the earnings portions) from an education IRA on behalf of the same student as long as the distribution is not used for the same educational expenses for which a credit was claimed.

10. Private prepaid tuition programs. Section 529 of the Code provides tax-exempt status to “qualified state tuition programs,” meaning certain programs established and maintained by a state (or agency or instrumentality thereof) under which persons may (1) purchase tuition credits or certificates on behalf of a designated beneficiary that entitle the beneficiary to a waiver or payment of qualified higher education expenses of the beneficiary, or (2) make contributions to an account that is established for the purpose of meeting qualified higher education expenses of the designated beneficiary of the account (a “savings account plan”). EGTRRA expands the definition of “qualified tuition program,” beginning in 2002, to include certain prepaid tuition programs established and maintained by one or more eligible educational institutions (which may be private institutions) that satisfy the requirements under code section 529. In the case of a qualified tuition program maintained by one or more private eligible educational institutions, persons are able to purchase tuition credits or certificates on behalf of a designated beneficiary but would not be able to make contributions to a "savings account plan" (as described in code section 529(b)(1)(A)(ii)). Except to the extent provided in regulations, a tuition program maintained by a private institution is not treated as qualified unless it has received a ruling or determination from the IRS that the program satisfies applicable requirements. Distributions from qualified tuition programs established and maintained by an entity other than a State used to pay for qualified higher education expenses are excluded from the recipient's taxable income beginning in 2004.

EGTRRA allows a taxpayer to claim a HOPE credit or Lifetime Learning credit for a taxable year and to exclude from gross income amounts distributed (both the principal and the earnings portions) from a qualified tuition program on behalf of the same student as long as the distribution is not used for the same expenses for which a credit was claimed.

11. Exclusion for employer-provided educational assistance. Employer-paid educational expenses are excludable from the gross income and wages of an employee if provided under a "section 127" educational assistance plan. Section 127 provides an exclusion of $5,250 annually for employer-provided educational assistance. The exclusion does not apply to graduate courses beginning after June 30, 1996. The exclusion for employer-provided educational assistance for undergraduate courses expires with respect to courses beginning after December 31, 2001. EGTRRA extends the exclusion for employer-provided educational assistance to graduate education and makes the exclusion (as applied to both undergraduate and graduate education) permanent. This provision is effective with respect to courses beginning after December 31, 2001.

12. Deduction for qualified higher education expenses. Under current law, taxpayers may not deduct the education and training expenses of either themselves or their dependents. However, a deduction for education expenses is allowed if the education or training (1) maintains or improves a skill required in a trade or business currently engaged in by the taxpayer, or (2) meets the express requirements of the taxpayer’s employer, or requirements of applicable law or regulations, imposed as a condition of continued employment. Education expenses are not deductible if they relate to certain minimum educational requirements or to education or training that enables a taxpayer to begin working in a new trade or business. In the case of an employee, education expenses (if not reimbursed by the employer) may be claimed as an itemized deduction only if such expenses meet the above described criteria for deductibility under section 162 and only to the extent that the expenses, along with other miscellaneous deductions, exceed 2 percent of the taxpayer’s adjusted gross income.

EGTRRA permits taxpayers an above-the-line deduction for qualified higher education expenses paid by the taxpayer during a taxable year. Qualified higher education expenses are defined in the same manner as for purposes of the HOPE credit. In 2002 and 2003, taxpayers with adjusted gross income that does not exceed $65,000 ($130,000 in the case of married couples filing joint returns) are entitled to a maximum deduction of $3,000 per year. Taxpayers with adjusted gross income above these thresholds would not be entitled to a deduction. In 2004 and 2005, taxpayers with adjusted gross income that does not exceed $65,000 ($130,000 in the case of married taxpayers filing joint returns) are entitled to a maximum deduction of $4,000 and taxpayers with adjusted gross income that does not exceed $80,000 ($160,000 in the case of married taxpayers filing joint returns) are entitled to a maximum deduction of $2,000. This provision expires at the end of 2005.

Estates and Gift Taxes

13. Phase-out and repeal of estate and generation-skipping transfer taxes.

EGTRRA makes the following changes:

• Beginning in 2011, the estate and generation-skipping transfers taxes are repealed.

• After repeal, the "basis" of assets received from a decedent generally will equal the basis of the decedent (i.e., carryover basis) at death. However, a decedent’s estate is permitted to increase the basis of assets transferred by up to a total of $1.3 million. The basis of property transferred to a surviving spouse can be increased (i.e., stepped up) by an additional $3 million. As a result, the basis of property transferred to a surviving spouse can be increased (i.e., stepped up) by a total of $4.3 million. In no case can the basis of an asset be adjusted above its fair market value. For these purposes, the executor will determine which assets and to what extent each asset receives a basis increase. The $1.3 million and $3 million amounts are adjusted annually for inflation occurring after 2010.

• From 2002 and through 2010, the estate and gift tax rates are reduced, the unified credit effective exemption amount is increased (from up to $1 million for lifetime transfers in 2004 to up to $4 million for deathtime transfers in 2010), and the generation-skipping transfer tax exemption amount is increased. The new rate structure is summarized in Table 7.

Table 7: Unified Credit Exemption; Highest Estate and Gift Tax Rates

calendar year	estate and generation skipping tax deathtime transfer exemption	highest estate and gift tax rate (percentage)
2002	$1 million	50
2003	$1 million	49
2004	$1.5 million	48
2005	$1.5 million	47
2006	$2 million	46
2007	$2 million	45
2008	$2 million	45
2009	$3.5 million	45
2010	taxes repealed	45
2011	taxes repealed	top individual income rate under EGTRRA (gift tax only)

• Beginning in 2011, the top gift tax rate will be 40 percent, and, except as provided in the tax regulations, a transfer to a trust will be treated as a taxable gift, unless the trust is treated as wholly owned by the donor or the donor’s spouse under the grantor trust provisions of the tax code.

IRAs and Retirement Plans

14. Individual retirement arrangements (“IRAs”). Under current law, an individual may make deductible contributions to an IRA up to the lesser of $2,000 or the individual’s compensation if neither the individual nor the individual’s spouse is an active participant in an employer-sponsored retirement plan. If the individual (or the individual’s spouse) is an active participant in an employer-sponsored retirement plan, the $2,000 deduction limit is phased-out for taxpayers with adjusted gross income (“AGI”) over certain levels for the taxable year. EGTRRA increases the maximum annual dollar contribution limit for IRA contributions from $2,000 to $3,000 for 2002 through 2004, $4,000 for 2005 through 2007, and $5,000 for 2008. After 2008, the limit is adjusted annually for inflation in $500 increments. In addition, individuals who have attained age 50 may make additional "catch-up" IRA contributions. The otherwise maximum contribution limit (before application of the AGI phase-out limits) for an individual who has attained age 50 before the end of the taxable year is increased by $500 for 2002 through 2005, and $1,000 for 2006 and thereafter.

15. Increase in benefit and contribution limits. Under current law, annual additions to a defined contribution plan with respect to each plan participant cannot exceed the lesser of (1) 25% of compensation, or (2) $35,000 (for 2001). Annual additions are the sum of employer contributions and employee contributions. The $35,000 limit is indexed for cost-of-living adjustments in $5,000 increments. Under a defined benefit plan, the maximum annual benefit payable at retirement is generally the lesser of (1) 100% of average compensation, or (2) $140,000 (for 2001). The dollar limit is adjusted for cost-of-living increases in $5,000 increments. EGTRRA increases the $35,000 limit on annual additions to a defined contribution plan to $40,000. This amount is indexed in $1,000 increments. It also increases the $140,000 annual benefit limit under a defined benefit plan to $160,000. The dollar limit is reduced for benefit commencement before age 62 and increased for benefit commencement after age 65. These changes are effective in 2002.

16. Increase in compensation limitation

Under current law, the annual compensation of each participant that may be taken into account for purposes of determining contributions and benefits under a plan, applying the deduction rules, and for nondiscrimination testing purposes is limited to $170,000 (for 2001). The compensation limit is indexed for cost-of-living adjustments in $10,000 increments. EGTRRA increases the limit on compensation that may be taken into account under a plan to $200,000. This amount is indexed in $5,000 increments. This provision takes effect in 2002.

17. Increase in elective deferral limit. Under current law, under certain salary reduction arrangements, an employee may elect to have the employer make payments as contributions to a plan on behalf of the employee, or to the employee directly in cash. Contributions made at the election of the employee are called elective deferrals. The maximum annual amount of elective deferrals that an individual may make to a qualified cash or deferred arrangement (a “section 401(k) plan”), a tax-sheltered annuity (“section 403(b) annuity”) or a salary reduction simplified employee pension plan (“SEP”) is $10,500 (for 2001). EGTRRA increases the dollar limit on annual elective deferrals under these kinds of plans to $11,000 in 2002. In 2003 and thereafter, the limits are increased in $1,000 annual increments until the limits reach $15,000 in 2006, with indexing in $500 increments thereafter.

18. "Roth contributions" to 403(b) plans. EGTRRA allows a section 401(k) plan or a section 403(b) annuity to include a “Roth contribution program” that permits a participant to elect to have all or a portion of the participant’s elective deferrals under the plan treated as Roth contributions. Roth contributions are elective deferrals that the participant designates (at such time and in such manner as the IRS may prescribe) as not excludable from the participant’s gross income. The annual dollar limitation on a participant’s Roth contributions is the annual limitation on elective deferrals, reduced by the participant’s elective deferrals that the participant does not designate as Roth contributions. The plan is required to establish a separate account, and maintain separate recordkeeping, for a participant’s Roth contributions (and earnings).

A qualified distribution from a participant’s Roth contribution account is not includible in the participant’s gross income. A qualified distribution is a distribution that is made after the end of a specified nonexclusion period and that is (1) made on or after the date on which the participant attains age 59, (2) made to a beneficiary (or to the estate of the participant) on or after the death of the participant, or (3) attributable to the participant being disabled. The nonexclusion period is the 5-year-taxable period beginning with the earlier of (1) the first taxable year for which the participant made a Roth contribution to any Roth contribution account established for the participant under the plan, or (2) if the participant has made a rollover contribution to the Roth contribution account that is the source of the distribution from a Roth contribution account established for the participant under another plan, the first taxable year for which the participant made a Roth contribution to the previously established account. A participant is permitted to roll over a distribution from a Roth contribution account only to another Roth contribution account or a Roth IRA of the participant.

This provision takes effect in 2006.

19. Nonrefundable credit to certain individuals for elective deferrals and IRA contributions. EGTRRA provides a temporary nonrefundable tax credit for contributions made by eligible taxpayers to a qualified retirement plan. The maximum annual contribution eligible for the credit is $2,000. The credit rate depends on the adjusted gross income (“AGI”) of the taxpayer. Only joint returns with AGI of $50,000 or less, head of household returns of $37,500 or less, and single returns of $25,000 or less are eligible for the credit. The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution. The credit offsets minimum tax liability as well as regular tax liability. The credit is available to individuals who are 18 or over, other than individuals who are full-time students or claimed as a dependent on another taxpayer’s return. The credit is available with respect to elective contributions to a section 401(k) plan, section 403(b) annuity, SIMPLE or SEP plans, and contributions to a traditional or Roth IRA. The rules governing such contributions continue to apply. The amount of any contribution eligible for the credit is reduced by taxable distributions received by the taxpayer and his or her spouse from any savings arrangement described above or any other qualified retirement plan during the taxable year for which the credit is claimed, the two taxable years prior to the year the credit is claimed, and during the period after the end of the taxable year and prior to the due date for filing the taxpayer’s return for the year. In the case of a distribution from a Roth IRA, this rule applies to any such distributions, whether or not taxable. The credit rates based on AGI are summarized in Table 10.

This provision is effective beginning in 2002. It expires at the end of 2007.

Table 10: Credit Rates Based on AGI

joint returns	heads of household	all other filers	credit rate ($2,000 maximum)
$0-30,000	$0-22,500	$0-15,000	50%
$30,000-32,500	$22,500-24,376	$15,000-16,250	20%