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2002 Tax Update
Dear Client:
The 2002 tax year is coming to an end, and it's time to think
about actions you should take by the end of the year to
minimize your taxes.
Even though tax rates are not changing next year, the amount
of income subject to the lower rates is increasing, due to
inflation. Thus, there is an incentive to postpone the
recognition of income and to accelerate expenses into 2002.
Make your Janua ry mortgage payment in December, pay any
state taxes due by the end of the year, and prepay deductible
expenses in December rather than postponing them until 2003.
Self-employed individuals should consider postponing the
collection of accounts receiv able to next year, while
employees may want to defer any bonuses. Sales of assets with
built-in gains should also be postponed until next year
(unless needed to offset losses that would otherwise be non-
deductible), while assets that will generate lo sses should
be sold this year.
Stock Market Losses
As the end of the year quickly approaches, you may be able to
use your losses in the stock market to reduce your tax
burden. While capital losses are first offset against
realized capital gains, any excess losses can be deducted
against ordinary inco me up to $3,000 ($1,500 if married
filing separately). Losses in excess of this limit can be
carried forward to later years to reduce capital gains or
ordinary income until the balance of these losses is used up.
Capital gains and losses on the sale or trade of investments
are classified as either short-term - if the property has
been held for one year or less - or long-term. Though these
two categories of capital gains and losses are subject to
different rates in the event of a net gain, a net capital
loss resulting from either category is directly deductible
from ordinary income up to the annual limit. This provision
can work to your advantage, yielding greater relief for
losses than if the long-term capital gains tax rate is used,
becaus e capital gains rates are generally lower than the
rates on ordinary income. Unfortunately, "paper losses" are
not deductible.
Bonus Depreciation
In March, a new law was enacted allowing a special 30 percent
first-year depreciation allowance for certain trade or
business property acquired after September 10, 2001. The
deduction is not prorated. If you placed property in service
after September 10 of last year and did not claim the
additional depreciation allowance on your 2001 tax return,
you may claim the deduction retroactively. However, this
must be done by April 15, 2003. Also, if you are thinking of
acquiring trade or business proper ty in early 2003, you may
want to consider accelerating the purchase into 2002 in
order to take advantage of the bonus depreciation provision
in 2002 rather than 2003.
Child and Dependent Care Credit
If you incurred child or dependent care expenses in 2002, you
are eligible for a credit. However, if your employer has a
flexible spending arrangement for child and dependent care
and you participate in that program, the amount excluded from
gross in come under the program reduces the amount available
for the credit and could even reduce your credit to zero.
Generally, it is more advantageous to pay your child and
dependent care expenses with funds from a flexible spending
arrangement and forgo t he credit. However, the expenses
eligible for the credit and the actual credit percentage are
both increasing next year so this might not be the case in
the future. If you will be in this situation next year, we
should evaluate whether or not you are better off
participating in the flexible spending arrangement.
Education Expenses
If you, your spouse, or a dependent are in school either as a
student or a teacher, there are several changes in the area
of education expenses which could affect you. First, you may
be able to deduct up to $3,000 of qualified higher education
tuitio n and related expenses paid for either yourself, your
spouse, or a dependent. This deduction, however, only applies
to taxpayers with adjusted gross income that does not exceed
$65,000 ($130,000 in the case of married couples filing joint
returns). I f you will be starting classes within the first
three months of 2003, you may want to consider paying the
tuition in December to avail yourself of the deduction. On
the other hand, expenses eligible for the lifetime learning
credit double from $5,000 to $10,000 for 2003 and, depending
on your tax situation next year, it may be more beneficial to
pay education expenses in 2003.
Second, two changes apply to the deduction for student loan
interest this year: the provision limiting your deduction to
interest paid during the first 60 months that payments are
required has been repealed and the modified adjusted gross
income phas e-out amounts are increased. Thus, if you have
student loan interest that was previously non-deductible
under these rules, we need to reevaluate whether you may now
qualify for a student loan interest deduction.
Third, you now have until as late as April 15 to make
contributions to a Coverdell education savings account for
2002. In 2002, individual contributions to a Coverdell
Educations Savings Account are deemed to have been made on
the last day of the pre ceding year if the contribution is
made on account of that preceding year and is made by the due
date of the individual's return for that preceding year (not
including extensions). In addition, a corporation may now
contribute to a Coverdell educatio n savings account.
Lastly, elementary and secondary school teachers may deduct
up to $250 of certain classroom material expenses in
arriving at AGI. The same deduction is available next year.
Thus, if you have plans to spend more than $250 on classroom
materials in the upcoming months, you may want to make some
of those purchases in December in order to maximize the
deduction.
Retirement Plan Limits
The amount of contributions or benefits that can be provided
for you as a participant under a qualified plan is limited,
based on the type of plan. This year, the amounts of
contributions and benefits that can be provided for you under
both defined c ontribution and defined benefit plans are
increased to the lesser of 100 percent of compensation or
$40,000. The limitation on the maximum annual benefit payable
on retirement under a defined benefit plan is generally the
lesser of 100 percent of ave rage compensation, or $160,000.
If you are an owner of a closely held business, and the
company has not taken advantage of the increased contribution
limits, there is still time to make additional contributions.
Retirement Plan Rollovers
There are now more options available for rolling over a
qualified plan distribution. Beginning in 2002, you can roll
qualifying distributions from a qualified plan into: (1) an
IRA; (2) another qualified plan that accepts rollovers; (3) a
Section 403 (b) annuity that accepts rollovers; or (4) a
Section 457 deferred compensation plan maintained by a
government or governmental entity that accepts rollovers. If
you are expecting a distribution from a qualified plan, we
should meet to discuss what th e best option for you would
be.
Changing Retirement Distribution Amounts
If you have already begun receiving fixed payments from your
IRA or retirement plan based on the value of your account at
the time you started receiving payments, you may now switch -
- without penalty -- to a method of determining the amount of
your payment based on the value of your account as it changes
from year to year. This change is effective for distributions
beginning in 2002 and for any series of payments beginning on
or after January 1, 2003. Thus, if there is an unexpected
drop in the value of your retirement savings, your required
minimum distributions are reduced, which will help you
preserve your retirement savings longer. We should discuss as
soon as possible whether this option would benefit you.
IRA Deduction Expanded
The amount you can contribute (and may be able to deduct) to
an IRA has increased. You and your spouse, if filing jointly,
may be able to deduct up to $3,000 ($3,500 if you are age 50
or over by the end of 2002) on your 2002 tax return. If you
were covered by a retirement plan, you may still be able to
take an IRA deduction if your modified adjusted gross income
is less than $44,000 ($64,000 if married filing jointly or
qualifying widow(er)). You have until April 15 to contribute
to an IRA.
Credit for Retirement Savings
New for 2002, you may be eligible for a credit of up to
$1,000 for qualified retirement savings contributions if your
adjusted gross income is $25,000 ($37,500 if head of
household, $50,000 if married filing jointly) or less. If you
are eligible for this credit and have not made a retirement
savings contribution, you should contact me to discuss what
can be done.
Earned Income Credit
Because the earned income credit has been expanded and
simplified for 2002, more people qualify for the credit. You
may be able to take the credit if a child lived with you and
you earned less than $33,178 ($34,178 if married filing
jointly) or a chi ld did not live with you and you earned
less than $11,060 ($12,060 if married filing jointly). In
addition, non-taxable earned income and modified adjusted
gross income are no longer taken into account. Instead,
taxable earned income and adjusted gro ss income are used to
determine if you can take the credit and the amount of the
credit. Finally, the alternative minimum tax no longer
reduces the amount of the credit..
Adoption Expenses
Expenses eligible for the adoption credit have increased this
year to $10,000 per child. However, the credit is phased out
if you have adjusted gross income exceeding $150,000.
Lifetime Gift Exclusion
You can now give away more of your estate, thus avoiding
estate taxes on that portion gifted away. The lifetime gift
exclusion has increased to $1,000,000 for both 2002 and 2003
with additional increases scheduled after that. If you are in
this situa tion and do not have a gift plan in place, we
should meet to consider your options.
Finally, for next year, you should be aware of the following
changes:
* The standard mileage rates decrease to 36 cents per mile
for all business miles driven and to 12 cents a mile for
the use of your care for moving and medical reasons.
* Employers can establish deemed IRAs under employer plans.
* The estimated tax safe harbor for higher income individuals
(other than farmers and fishermen) has been modified for
2003 estimated tax payments. If your 2002 adjusted gross
income is more than $150,000 ($75,000 if you are married
filing a separate return for 2003), you must have deposited
the smaller of 90 percent of your expected tax for 2003 or
110 percent of the tax shown on your 2002 return to avoid an
estimated tax penalty.
* The child and dependent care credit increases from 30
percent to 35 percent of qualifying expenses, the maximum
adjusted gross income that qualifies for the highest credit
rate increases to $15,000, and the limit on the amount of
qualifying expense s increases to $3,000 for one qualifying
individual and $6,000 for two or more qualifying individuals.
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