It's as if baby boomers, would-be parents and families that go to school formed a coalition that successfully lobbied for federal income tax breaks. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), enacted June 7, benefits all those constituencies plus one more: financial advisors.

"In a very perverse sense, this is a good bill for us because business will be good," says advisor Tim Casserly, also an attorney, of Albany, N.Y. "It's just a shame people won't be able to figure out what's up (on their own)."

The new law, a potpourri of effective and sunset dates spiked with phase-ins and phase-outs, unequivocally creates complexity. The universe of clients needing your tax-savvy guidance through the maze includes the affluent, business owners and potential victims of the alternative minimum tax. (The new law's estate tax implications are discussed in a separate article in this issue.)

The good news is that you don't need to memorize EGTRRA by tomorrow. Some opportunities, like the Roth 401(k), aren't effective for half a decade, making immediately actionable items few in number. (One is telling owners of C corporations that the due date for this year's third-quarter corporate estimated taxes has been pushed back to October 1.

Certainly, everyone is aware that the U.S. Treasury is sending checks (direct deposit not available) to Americans who had taxable income in 2000. What you may not know is: 1) Nonresident aliens are not eligible for this money, 2) Individuals who extended their 2000 tax returns won't see a check until they file and 3) On clients' 2001 returns, you'll complete a worksheet reconciling 2001 income with the amount of any check received because the check is an advance payment of a 2001 tax credit. Those who have recently relocated will get their checks if they filed a change of address with either their post office or the Internal Revenue Service.

The law creates a new 10% tax bracket for individuals by carving the first $6,000 ($12,000 for married couples) from the 15% bracket, retroactive to January 1. The new floor enhances the benefit of minors' accounts, says Jere Doyle of Mellon Private Asset Management in Boston. "If you've got a child 14 or over, so that you won't get hit with the kiddie tax, consider transferring CDs or stocks producing dividends to a custodian account for the child, to shift up to $6,000 in dividend and interest income," Doyle says.

All brackets above 15% fell by a percentage point on July 1 (with concomitant changes in wage withholding) and will drop another 1% in 2004, to be followed by a final 1% decrease in 2006 (except for the top bracket, which then tumbles 2.6% to 35%). This slow slide in tax rates "is not so dramatic that you'd turn your planning on its head," says Mark Sellner, managing principal of tax services for the national accounting firm Larson Allen in Minneapolis. Still, deferring income to a later tax year while accelerating deductions makes sense on the margin, and it's certainly worth re-examining the benefit anticipated from municipal-bond ladders that extend into the years when rates reach their nadir. A major tax-planning curveball: Rates return to their pre-EGTRRA levels in 2011, without further legislation.

Lower rates may improve the utility of tax-deferred plans for those nearing retirement, says advisor Bill Bengen, of El Cajon, Calif. He previously counseled high-bracket wage earners in their fifties to discontinue qualified-plan contributions in favor of pursuing capital gains in taxable accounts, if they were anticipating a similar ordinary tax bracket in retirement. But as ordinary rates creep down, reducing their differential to capital gains, clients may need to be closer to retirement before the benefit of capital-gains rates outweighs the tax-deferral, Bengen says. "I may have to review my recommendations to folks." The asterisk is that Washington is making noise about reducing the capital-gains tax later this year.

As good as lower ordinary rates sound, they'll cause more Americans to face the alternative minimum tax, which has not had its thresholds reduced by the new law. (As a client's regular tax falls, AMT is more likely to exceed it.) Reduced withholding during this year's second half, exacerbated by a drop to a flat 27.5% withholding on bonuses (down from 28%, effective August 7), could make April 15 nasty, warns CPA and advisor Bernard Kiely. "If a client is not going to benefit from the lower tax rates because of the AMT, you'd better make estimated tax payments so that there isn't a penalty," says the head of Kiely Capital Management Inc. in Morristown, N.J. EGTRRA does increase the AMT exemption amount by a modest $2,000 for single filers ($4,000 joint), effective this year, but that disappears after 2004.

Also effective for 2001: The child tax credit for a dependent rises from $500 to $600, through 2004. The credit increases to $700 per child in 2005, $800 in 2009 and $1,000 in 2010. Who says kids cost more as they get older?

Planning For 2002

Clients praying to adopt a child get a tax break if they can wait. Next year, the adoption credit jumps to $10,000 per eligible child and doesn't begin phasing out until modified adjusted gross income reaches $150,000 (vs. $75,000 in 2001). The adoption credit is henceforth permanently allowed against the alternative minimum tax.

For the advisor eyeing opportunities to consult with small-business owners, a new tax credit helps pave the way. Beginning in 2002, small businesses can get a credit for 50% of the first $1,000 of administrative and retirement-education expenses incurred to establish a new retirement plan, be it a defined benefit, 401(k), SIMPLE or simplified employee pension (SEP) plan. The other 50% is deductible as an ordinary business expense. The credit is available for each of the first three years of the plan. "There must have been 100 or fewer employees in the preceding year, and the plan has to be established in 2002 or later," says Neil Brown of Abacus Planning Group, in Columbia, S.C.

The credit providing businesses with an incentive to launch pension plans dovetails with provisions that will boost the public's need for retirement-planning advice. Next year, the limit on contributions to 401(k) plans, 403(b) annuities, salary-reduction SEPs and 457 plans rises to $11,000. The limit increases $1,000 each year through 2006 and is indexed thereafter.

For SIMPLE plans, the contribution limit rises to $7,000 in 2002 (up from $6,500 this year) and increases $1,000 annually through 2005, with indexing beginning in 2006.

Here's where the Woodstock generation wins with EGTRRA: Starting in 2002, a plan participant age 50 by the end of the plan year may make an additional "catch-up" contribution. For 401(k), 403(b), SEP and 457 plans, the additional amount is $1,000 for 2002, and it increases by $1,000 annually through 2006, with indexing thereafter. "So by 2006, if you happen to be at least 50, you can put $20,000 into your 401(k) plan ($15,000 regular contribution, plus $5,000 catch-up), which is a chunk of change," says Gayllis R. Ward, a senior vice president in the tax department of Fiduciary Trust Co. International in New York.

Participants in 457 plans who are nearing retirement have it even better. In the three years prior to retirement, the regular contribution limit is doubled (although the catch-up provision does not apply).

For SIMPLE plans, the catch-up amount is $500 next year, increasing by $500 annually through 2006, followed by indexing.

Now, you're probably thinking: "The higher limits look nice on paper, but clients' budgets can't take the hit." EGTRRA immediate-action item No. 2: Revisit clients' cash-flow plans for 2002. If you firmly believe in the benefit of tax deferral for a client, don't you owe it to her to help find a way of maximizing that benefit? "You need to have some very candid discussions about lifestyle choices and do a good job illustrating the impact that cutting some corners today will have five, 10, 15 years from now," says Beth V. Walker, a chartered retirement planning counselor with First Montauk Securities in Las Vegas. Help your clients by getting them to think about next year's budget now and explain that a pretax dollar contributed is less than a buck out-of-pocket, Walker says.

A new credit (available 2002 through 2006) for contributions to qualified plans lets a wealthy clan help its young adults in entry-level jobs save for retirement. Available when adjusted gross income is less than $25,000 ($50,000, if married) for taxpayers 18 and older who are neither full-time students nor dependents, the credit is as much as 50% of the first $2,000 contributed to an employer-sponsored plan or traditional or Roth IRA. Larson Allen's Sellner is recommending affluent clients gift $2,000 of appreciated stock to an adult child who then sells it at a low rate, uses the proceeds to fund the plan contributions and takes the new credit to cover the reported gain. "The family comes out ahead, and it's a good way to get the kids accustomed to saving for retirement," Sellner says.

Contribution limits on traditional and Roth IRAs rise to $3,000 for 2002 through 2004, $4,000 for 2005 through 2007 and $5,000 in 2008 (with indexing thereafter). The 50-plus crowd can contribute an additional $500 a year beginning next year; the annual catch-up rises to $1,000 beginning in 2006.

Education Planning

EGTRRA's biggest bonanza is its cornucopia of tax incentives for education, which kick in next year.

Start with an improvement in the "above-the-line" deduction for student-loan interest, which has had its income phase-out range pushed higher. The new range is $50,000 to $65,000 for singles and double that for marrieds. "And in the past, you could only deduct interest for the first 60 months (of the loan)," says Mellon's Doyle. "Now, you'll be able to deduct the interest as long as you carry the loan."

Even better is the new law's upgrade of Education IRAs. Beginning in 2002, up to $2,000 may be contributed to an Education IRA for a beneficiary as late as April 15 of the following year. Further, contributions can be made by joint filers with income as high as $220,000 (up from $160,000) and by corporations, tax-exempts and other entities without regard to entity income. The real boon is that Education IRAs can make tax-free distributions to pay for tuition, room, board and more at public and private elementary and secondary schools (K through 12), transforming what had been college planning into the broader field of education planning. "If a client wants to send a child to private high school, or if a client has an autistic child in special programs that aren't part of the public school system, you can help them fund that through an Education IRA," says Doyle.

EGTRRA reaches out to families of the handicapped by permitting contributions to a special-needs beneficiary's Education IRA after age 18. Nor does a special-needs beneficiary need to empty the account by age 30, the new law says.

Section 529 plans are hot, according to advisor Ray Loewe, with Financial Resources Network in Marlton, N.J. Effective next year, distributions are tax-free (currently they're taxed at the student's ordinary rate) and rollovers become infinitely easier to execute, providing an exit opportunity if you don't like a plan's investment manager. Loewe points out that 529 money continues to count against you for financial-aid purposes. "But if you're not going to get aid because family income is $100,000 or more, the tax-free treatment suddenly makes these plans very favorable," he says.

Tomorrow Never Knows

Some EGTRRA provisions aren't effective for years-the itemized-deduction and personal-exemption phase-outs begin to disappear in 2006, for example-leading to "speculation that we won't see a lot of these things to fruition," says Luther Brotherhood Assistant Vice President Rick Edinger. Moreover, the entire act self-destructs after 2010, "as if the provisions of and amendments made by the bill had never been enacted," a U.S. House of Representatives summary reads. That further complicates your long-term planning efforts.

But then, if it were simple, clients wouldn't need you in the first place. "The rules change all the time," says planner Cheryl Holland, with Abacus Planning. "whether it's the investment environment or regulatory issues or Social Security benefits. This is just another moving target."