Take These Breaks Before They Disappear
Ignorance could prove particularly costly this tax season.
A host of new and improved tax deductions and credits kicked in during 2002, and sharp-eyed taxpayers -- or their accountants -- can save significant money on their returns this year.
But being tax-savvy is tougher than ever. The nation’s already complicated tax code is increasingly freckled with temporary changes, income tests and phaseouts, giving a now-you-see-them-now-you-don’t quality to many of the most lucrative tax breaks.
“It’s even difficult for tax professionals to keep up,” said Marilyn Barrett, a Los Angeles tax partner with Alschuler Grossman Stein & Kahan. “There are changes that only go in effect this year. There are changes that people may think have gone into effect but haven’t yet. And there’s a panoply of proposed changes. It’s a very tough year.”
Here’s a rundown of significant new tax laws, Internal Revenue Service rules and tax court rulings that could affect returns due this April 15:
* Savers credit. This new credit provides as much as 50 cents in tax benefits for every dollar contributed to a qualified retirement plan by low-income filers. Qualified retirement plans include 401(k), 403(b) and 457 plans, as well as traditional individual retirement accounts and Roth IRAs.
The credit is set up according to a stair-step formula, providing tax breaks equal to 10% to 50% of retirement plan contributions of as much as $2,000 annually, with the lowest-income filers getting the biggest credit. Once a single filer’s adjusted gross income exceeds $25,000 or a married couple’s income hits $50,001, the credit phases out.
IRA contributions for the 2002 tax year can be made until April 15, so taxpayers who didn’t know about the credit can still claim it by making contributions until then.
There are two caveats.
Parents who can claim the earned income tax credit should seek professional tax advice before contributing to a tax-deductible account, such as a traditional IRA, to claim the savers credit, according to Brenda Schafer, senior tax research coordinator with H&R; Block. Tax-deductible retirement plan contributions may reduce the earned income credit, which can be more lucrative than the savers credit. That doesn’t mean that those individuals should ignore the savers credit. They should simply save through a nondeductible plan such as a Roth IRA, Schafer said.
Also, don’t fall in love with the savers credit. It’s temporary, available only for tax years 2002 to 2006.
* Earned income tax credit. Rules for this credit changed last year, allowing filers with somewhat higher incomes, as well as those receiving nontaxable income such as free or subsidized military housing, to claim the lucrative break.
* Education deduction. There’s a new deduction of as much as $3,000 for those paying tuition and fees for higher education. To claim it, a taxpayer must pay higher-education costs for himself, a spouse or dependent and have adjusted gross income of less than $130,000 if married or $65,000 if single.
“This is a case where one dollar of additional income could lose you a $3,000 deduction,” said Martin Nissenbaum, national director of personal income tax planning at Ernst & Young in New York. “This is where it becomes really important for people who are near that ‘cliff’ to do what they can to reduce their adjusted gross income.”
So-called before-the-line deductions -- such as contributions to employer-sponsored benefit plans and traditional IRAs, alimony payments and some expenses for small-business owners -- are key, Nissenbaum said. Before-the-line deductions reduce the taxpayer’s adjusted gross income, which is used to calculate eligibility for other deductions and credits, such as this one.
* Teacher tax break. Teachers who buy supplies for their classrooms can deduct as much as $250 annually of these unreimbursed costs. Taxpayers don’t need to itemize to claim educator expenses, which are a new before-the-line deduction.
This deduction is available only in the 2002 and 2003 tax years, but President Bush’s new budget plan would boost the allowable deduction and make the educator expense write-off a permanent part of the tax code.
* Student loans. Interest expenses on a student loan, which previously were deductible only in the first 60 months of repayment, now are deductible no matter how old the loan. The deductions are phased out for those earning more than $50,000 when single or $100,000 when married, filing jointly.
* Self-employed’s health care. Self-employed individuals can deduct as much as 70% of the health insurance premiums they paid in 2002, up from 60% in 2001. Starting in 2003, self-employed individuals can deduct all of these costs.
* Retirement contributions. Allowable maximum contributions to retirement plans were raised in 2002 to $11,000 for 401(k), 403(b) and 457 plans, and to $3,000 for IRAs. Contributions to employer-sponsored plans must have been made during 2002 to be deductible on this year’s tax returns. But IRA contributions can be made until April 15th and still be claimed as deductions this year by some taxpayers.
Taxpayers qualify for full IRA deductions when they aren’t covered by qualified retirement plans at work, or when their adjusted gross income is below set thresholds. Those thresholds were raised in 2002 to $34,000 for singles and $54,000 for married couples.
* “Catch-up” contributions. Individuals age 50 and over in 2002 were allowed to make catch-up contributions to their retirement plans. The maximum catch-up contribution to a 401(k) or 403(b) plan was $1,000; it was $500 for those contributing to an IRA. IRA catch-up contributions can be made until April 15 and still be claimed on 2002 tax returns.
* Adoption credit. Adopting parents can claim an adoption tax credit of as much as $10,000 per eligible child, up from the previous maximum credit of $5,000. An eligible child is defined as someone under the age of 18 or someone over 18 who is physically or mentally incapable of caring for himself.
This credit is designed to reimburse parents for attorney’s fees, court costs and other expenses directly related to adopting. The credits begin to phase out for couples with adjusted gross income exceeding $150,000 and are unavailable to those earning more than $190,000 annually.
Qualifying taxpayers adopting children with special needs can deduct as much as $10,000 per adoption, regardless of their actual expenses.
* Weight-loss break. A 2002 tax ruling created a deduction for weight-loss programs. Program expenses for those diagnosed by a physician as obese can be claimed as medical expenses, which are deductible once they exceed 7.5% of a taxpayer’s adjusted gross income.
* New tax brackets and inflation adjustments. These also kicked in during 2002. The new 10% rate now is in effect. The 15% rate remained the same, while rates above 15% declined by a half-percentage point to 27%, 30%, 35% and 38.6%.
Standard deduction amounts rose to $7,850 for married couples; $4,700 for singles; and $6,900 for heads of households. In 2001, the standard deduction for married couples was $7,600. It was $4,550 for singles and $6,650 for heads of household. Personal exemption amounts rose by $100 to $3,000.
* Interest and dividends. The one significant simplification this year: A separate form is no longer required to detail interest and dividend income if it is less than $1,500 annually. Previously, a Schedule 1 was required once dividend and interest income exceeded $400.
