Important Changes for 2001

This section summarizes important tax changes that took effect in 2001. These changes are discussed in more detail throughout this publication.

Changes are also discussed in Publication 553, Highlights of 2001 Tax Changes.

Tax relief for victims of terrorist attacks. At the time this publication was being prepared for print, Congress was considering legislation that would provide tax relief for individuals affected by terrorist attacks against the United States.

For more information, see Publication 3920.

Reduced tax rates. For tax years beginning in 2001, the income tax rates have been reduced. The following items highlight these changes.

10% tax rate. A portion of your income that would be subject to the 15% tax rate is subject to a reduced rate of 10%. For 2001, most individuals receive the benefits of the 10% 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 and will receive the benefits of the 10% rate by completing a worksheet in the form instructions.

Other tax rates. The other tax rates, 28%, 31%, 36%, and 39.6% are reduced to 27.5%, 30.5%, 35.5%, and 39.1%, respectively. These reduced rates should have been reflected in amounts withheld (such as backup withholding) on certain payments made after August 6, 2001.

Advance payment of income tax. If you received an advance 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. See chapter 38.

Child tax credit. The maximum child tax credit for each child is increased to $600. The qualifications for claiming the additional child tax credit have been changed to include a qualifying individual with fewer than 3 children. See chapter 35.

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. See Publication 970, Tax Benefits for Higher Education.

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 phaseout is increased. The amounts vary depending on filing status. See chapter 18.

Alternative minimum tax (AMT). The AMT exemption amounts are increased. See chapter 31.

Schedule D tax computation simplified. The tax computation on Schedule D is now easier for most taxpayers. For information on completing Schedule D, see chapter 17.

Lower capital gain tax rate. A new capital gain tax rate applies to gain that is "qualified 5-year gain." Qualified 5-year gain is long-term capital gain from the sale of property that you held for more than 5 years and that would otherwise be subject to the 10% capital gain rate. See chapter 17.

Election to recognize gain on property held on January 1, 2001. You can elect to treat certain assets held on January 1, 2001, as sold and then reacquired on the same date. The purpose of this election is to make any future gain on the property that would otherwise be subject to the 20% capital gain rate eligible for the 18% rate if the property is held for more than 5 years from the date reacquired. See Publication 553.

Foreign earned income exclusion. The amount of foreign earned income that you can exclude increased to $78,000. See Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

Standard mileage rate. The standard mileage rate for the cost of operating your car increased to 34 1/2 cents a mile for all business miles driven. See chapter 28.

Minimum required distributions. Until final regulations are issued, proposed regulations can be relied on to determine the minimum required distribution from certain qualified plans and individual retirement arrangements (IRAs). These regulations simplify the rules for distributions during the life of the employee (or IRA owner) and for distributions after the death of that individual. In most cases, these regulations reduce the minimum required distribution. For information on IRA distributions, see chapter 18. For information on distributions from certain qualified plans, see Publication 575, Pension and Annuity Income.

Certain amounts increased. Some tax items that are indexed for inflation increased for 2001.

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. See chapter 37.

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. See chapter 21.

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 high income. See chapter 3.

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 filing separately). See chapter 22.

Social security and Medicare taxes. The maximum wages subject to social security tax (6.2%) is increased to $80,400. All wages are subject to Medicare tax (1.45%).

New names for certain tax provisions. The names used to refer to certain tax provisions have been changed.

• Medical savings accounts (MSAs) are now Archer MSAs. For information on Archer MSAs, see Publication 969, Medical Savings Accounts (MSAs).
• Education individual retirement accounts (education IRAs) are now Coverdell education savings accounts (Coverdell ESAs). For information on Coverdell ESAs, see Publication 970, Tax Benefits for Higher Education.

Parent of a kidnapped child. The parent of a child who is presumed by law enforcement authorities to have been kidnapped by someone who is not a family member may be able to take the child into account in determining his or her eligibility for the following.

• Head of household or qualifying widow(er) with dependent child filing status.
• Exemption for dependents.
• Child tax credit.
• Earned income credit.

See Publication 501, Exemptions, Standard Deduction, and Filing Information and Publication 596, Earned Income Credit (EIC).

Payments to Holocaust victims. Restitution payments received after 1999 (and certain interest earned on the payments) are not taxable and do not affect the taxability of certain benefits, such as social security benefits. You may have to file Form 1040X if you included these amounts in income on your 2000 tax return or if you used the payments in any computation affecting your tax liability. For more details, see chapter 13.

Third party designee. Beginning with your tax return for 2001, you can check the "Yes" box in the "Third Party Designee" area of your return to authorize the IRS to discuss your return with a friend, family member, or any other person you choose. This allows the IRS to call the person you identified as your designee to answer any questions that may arise during the processing of your return. It also allows your designee to perform certain actions. See your income tax package for details.

Mailing your return. You may be mailing your return to a different address this year because the IRS has changed the filing location for several areas. If you received an envelope with your tax package, please use it. Otherwise, see your tax form instructions.

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